Nature Of The Fraud Accounting Essay


The nature of the fraud was the governance of Megan Media failure began when it two subsidiaries which are Memory Tech Sdn. Bhd. and MJC Pte Ltd. defaulted on a RM47 million payment to bondholders. This failure resulting to reporting failure whereby a preliminary report found that "substantial irregularities" and financial position of the company's financial position had been misstated and RM211 million deposits for 13 production lines was fictitious (Kathy Fong : RM300mil suspect deals at Megan Media unit, The Star Online, 2007). The financial consultant, Ferrier Hodgson investigate MTSB debt where have financed the payment of fictitious trading creditors through borrowings and recycled the cash through other entities to appear that repayments were being made by fictitious trading debtors. Consequently it resulted to the receivables amounting RM334.4 million. This transaction was claimed that all trading creditors were paid but the payments were actually made to other parties, a move to siphon out the cash from MTSB. The trading debtors, however, remained outstanding and the debts were unlikely to be collected at all (Kathy Fong: RM300mil suspect deals at Megan Media unit, The Star Online, 2007). In April 2007, the loss of Megan Media reported amounting to RM1.3 billion compared to a profit of RM60 million in the previous year (Mat N.N., Mohamad Z.Z., &Chek T.I., 2011).

1.1 How It Was Discovered

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It was found that there was fraudulent trading in the company. There is because there was a default of RM900 million of bank loan. As a result, it incurred a net loss of RM1.27 billion in the financial year which ended in April 2007 (Krishnan, L., 2011). However, the auditors failed to report the matter to the shareholders of the company. They also did not report the matter to the regulators. This shows that they have failed in their duties to whistle-blow (Krishnan, L., 2011). On June 7, 2007, Megan Media said investigative accountants had uncovered fraudulent activities within the company, which may result in a shortfall of RM456 million in its net realisable value. The scandal apparently involved fictitious invoices, payments and trade creditors, and possible embezzlement by internal executives. The fraudulent activities were also said to involve fabricated trading activity and false deposit payments for equipment purchases at its core subsidiary MTSB. Following the shortfall in its net realisable value and its ability to meet its debt obligations, Bursa Malaysia has declared Megan a PN1 status company.

1.2 Company's Background

Megan Media Holdings Berhad ("MEGAN") Group was established in early 1994. The principal activities of the MEGAN Group started from producing plastic injection components to a range of electronics and automotive parts. Recognising the future prospects of the data storagemedia industry in 1996, MEGAN ventured into the manufacturing of 3.5" MFD and videotapes under Memory Tech Sdn Bhd ("MTSB"), subsidiary of MEGAN. In 1999, MTSB expanded into the manufacturing of compact disc-recordable (CD-R) and digital versatile disc-recordable (DVD-R).

It became the first Malaysian company to receive pioneer status from the Ministry of International Trade and Industries for manufacturing optical data storage products.On August 8, 2000, Megan Media Holdings Bhd was listed onto the Second Boardof the Kuala Lumpur Stock Exchange. Megan's entire share capital was transferred from the Second Board to Main Board of the Exchange under the "Industrial Products" sector with effect Tuesday, December 3, 2002. The aggressive marketing strategy has resulted in the company achieving a prominent footing as the largest manufacturer of CD-R and DVD-R in the country.Plus, MEGAN's core business is focused on the manufacture of optical storage products (CD-R and DVD-R) and marketing of magnetic storage products (3.5"MFD and videotapes).As a worldwide manufacturer and distributor, Megan provides a competitive advantage by producing superior quality products and offering competitive price, with exceptional customer services. Megan is committed to build a long-term relationship of trust and loyalty with their customers.

The business was founded by the late Tan Sri Dato' Mohd Yusof binAbdul Rahman, the former chairman of Affin Group, Tan Sri Dato' Dr Haji Abdullah bin Abdul Rahman, the former Director General of the Ministry of Health and also Mr Yeo Wee Siong, previously the executive director of the group. Mr Yeo Wee Siong, a Singaporean, is also the founder of MJC (Singapore) Pte Ltd. Acquired share in MJCS in year 2004. MJC Singapore Ltd (MJCS) is principally involved in the original equipment manufacturer (OEM) supply and distribution of data storage products such as video cassette tapes and housing, floppy diskettes, blank CDs and DVDs. The proposed acquisition of MJCS involves:

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Sale of 100% stake in MJCS to Megan for USD25.6 million (RM97.3 million);

Disposal of MJCS's 11.1% stake in Megan to Yeo Wee Siong, one of Megan's directors and founders.

Megan also assumed MJCS debt of RM100 million. The exercise was completed in January 2004.The proposed acquisition is in line with Megan's plan to expand its market share in the data storage products industry. Additionally, the acquisition will also allow Megan immediate access to MJCS' established marketing network and manufacturing expertise. As at financial year 2005, MJCS contributed 20% to Megan's financial year 2005 net profit.

1.3 The Actions Were Taken Against the Company

Security Commission (CG) is body who responsible to take proactive approach in responding to the need of the industry. These responsibilities are includes improving processing time, raising the level of transparency and bringing local listing rules in line with international best practices.

The Bursa Malaysia and SC had gazette new rules for the public listed companies. They were required to disclose their financial status, shareholders structure and loan position on a quarterly basis. A company's manager is subjected to penalty or jail sentence if they fail to comply with the rules. The government had granted a warrant amounting to US$100,000 to Malaysia Institute of Corporate Governance (MICG) to conduct research and training program in order to improve the corporate governance standard and quality (Das,2000: 19).

In this fraudulent of financial reporting done by Megan Media, SC has charged two Megan Media's directors with furnishing false revenue figures to Bursa Malaysia. The offences under the Securities Industry Act (SIA) 1983 were charged to Megan Media's financial controller and their chairman cum director that carries a fine not exceeding RM3 million, or imprisonment of not more than 10 years, or both, according to the statement.

1.4 Prevention and Detection

The Sarbanes-Oxley Act of 2002 is one of the actions to prevent and helped reduce financial reporting fraudulent. Many of its requirements were intended to raise the standard of corporate governance and mitigate the risk of fraudulent financial reporting. In particular, the act reinforces the responsibility of corporate officers for the accuracy and completeness of corporate financial reports, and adds a requirement for the public certification of each periodic report filed with the SEC that includes financial statements. The chief executive officer and chief financial officer must certify that each such periodic report complies with the requirements of the Securities Exchange Act of 1934 and that the financial statements are fairly presented;

Establishes criminal penalties for a wilful and knowing untrue certification;

Provides for the disgorgement of the bonuses and profits of executives involved in fraudulent financial reporting;

Requires evaluations and increased disclosures of a company's internal control over financial reporting by management, and a related report by the external auditor for certain companies;

Requires other enhanced disclosures, including whether the company has a code of ethics for senior financial officers;

Enhances the role of the audit committee, including requirements for financial expertise and responsibility for oversight of the company's external auditor; and

Requires companies to establish whistleblower programs, and makes retaliation against whistleblowers unlawful.

Furthermore, in order to prevent the fraudulent activities, shared of responsibility to the investing public can be take to mitigating the risk of financial reporting fraud. These responsibilities can be assign to four parties such as; Board and Audit Committee, Internal Audit, External Audit and Management. Here are techniques that company can use to uncover fraud such as:

Do surprise audits by the internal audit function. IA should have the authority to go in and audit any group without advance notice. This could be in reaction to an anonymous tip or as part of its regular rotation. This is especially important whenever cash is involved, as in petty cash box.

Create a check and balance on Master Vendor File Report and have it reviewed by a senior executive. It should be run periodically as appropriate for your activity, either weekly or monthly. Its purpose is to identify any unusual or potentially fraudulent activity.

Do background checks on any employee handling money. Someone who has committed fraud before is likely to repeat it, especially if the individual is having personal financial difficulty.

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Set up responsibilities employing appropriate segregation of duties. Sometimes when a new function or process is put in place, the segregation issue is completely overlooked. Occasionally, a company employs perfect segregation of duties and then ruins it by giving one person access to everything, usually a manager responsible for the function.

Employ the "eyeball test" when it comes to reviewing data. Train employees to take a step back and look at the data objectively.


2.0 Nature of the Fraud

The nature of the fraud was the uses of fraudulent accounting method by add on huge earning in 2002 to cover the liability of acquired by company. When the earning is high, it will show that the company financial growth is high and will make the price of WorldCom's stock increase.

The creative accounting was done by classified over $3.4 billion for line costs that is interconnection expenses with other telecommunication companies as capital expenditure. When the cost have been capitalised, meaning that WorldCom to spread them over many year as capital will have depreciation. Line cost supposed to record as expenses as WorldCom paid other companies because of the usage of their communication networks. Access fees and transport charges are consist in line cost expenses charges for messages for WorldCom customers. This misclassified were done between 2011 and first quarter 2002.

2.1 How It Was Discovered

Cynthia Cooper was WorldCom internal auditor. She acted as whistle-blower as she discovered the treatment of line cost as capital expenditure in May, 2012. The auditor discussed the treatment with the Chief Financial Officer (CFO) Scott D.Sullivan and David F. Myers, company's controller. Head of Audit Committee WorldCom board of directors, Max Bobbitt is the one that Ms Cooper reported about the fraud and Max Bobbit asked KPMG, current auditor if the company to investigate this matter. WorldCom previous outside company was Arthur Andersen since 1989 and been replaced by KPMG on 16 May, 2002.

Arthur Andersen audit qualities have been question as the fraud done by WorldCom might be caught earlier. On June 25, 2002, WorldCom announced that it had overstated earning in 2001 and the first quarter by more than $3.8. Ms. Cooper asked the company regarding the capital expenditure and Sullivan have been denied.

2.2 Company's Background

WorldCom is a long distance telephone service provider company. WorldCom started as a small company in Mississippi, in Southern United State. In 1983 Murray Waldron and William Rector got started this business as WorldCom previously known as LDDS. LDDS change name to WorldCom in 1995. WorldCom CEO is Bernard Ebbers who was known as a very aggressive businessman, risk seeking and one of the men behind every fraud in WorldCom.

WorldCom mission was to be most profitable, single service provider of communication services around the world. WorldCom CFO was Scott Sullivan, who always directed the staff to make false and misleading public statement regarding finances.

Early at 1990's, WorldCom make a massive step by making rapid acquisition of other telecommunication firms and successfully increased their reported revenue by $39.2 billion in 2001 instead of their previous revenue in $154 million in 1990.

WorldCom purchased over 60 firms in second half of 1990. Some of the company acquired by WorldCom was MCI, UUNet, CompuServe, and America Online Data Network. Therefore, WorldCom was rated as second largest long-distance operators in 1998 until 2002.

2.3 The Action Were Taken Against the Company

WorldCom scandal was under Chapter 11 of bankruptcy in United States of America, as the corruption has been making a really big impact to America economy after the scandal happen to Enron. The accounting scandal also make an impact to the financial world whereby there are too many producers need to be follow by an auditor. This scandal happens to be against too many parties in USA involved on the financial accounting scandal.

At time of the scandal have found by the internal team of auditor in WorldCom, it shows that a really big amount have been manipulate by the top management of WorlCom in year 2004 with about $5.7 billion in debt and $6 billion in cash. About half of the cash was intended to pay various claims and settlements. Previous bondholders ended up being paid 35.7 cents on the dollar, in bonds and stock in the new MCI Company. The previous stockholders' stock was cancelled, making it totally worthless. It had yet to pay many of its creditors, who had waited for two years for a portion of the money owed. Many of the small creditors included former employees, primarily those who were dismissed during June 2002 and whose severance and benefits were withheld when WorldCom filed for bankruptcy.

After found out about the scandal that happen in WorldCom, Security Commissioner taking part to investigate and analysis the accounting practices to understand the overall situation of the WorldCom. The investigation committee appointed by WorldCom and on an investigation conducted by the auditor that found more accounting misstatement appear for a past few years of the WorldCom accounting activities.

The impact of this WorldCom scandal also make an action by the White House as the drop of share price are make an impact to the United Stated Of America economy activities. The drop of share price is giving a most important threat of the economy itself.

As a result of all this SEC are making immediate approached to court seeking orders prohibiting WorldCom and its affiliates from destroying, hiding or altering relevant documents and prohibiting the company to make any extraordinary payment.

2.4 Prevention and Detection

In our opinion, the best action to take to prevent and detect such fraud that happen to the WorldCom is that the internal audit committee should be more alert to detect the misstatement the appear in the financial statement. The stakeholder of WorldCom also need be part of the internal audit committee to ensure that top management doesn't not making any advantage of the financial statement prepared by a CFO and an accountant. The an ethical behaviour that have been done by top management of WorldCom are really make shocking to the accounting history whereby the creative accounting and manipulation of the accounting figure are making a really big impact on the performance of the company.

The changes in the share price are really make a big impact to the economy whereby the government should take more serious issue to prevent this accounting scandal happen again as their need to monitor and evaluate the financial statement that have been presented to the public and the auditor that taking responsibility to give an opinion to the financial statement should be more responsible on the job function.

If the auditor can detect the fraud that have been made for almost 4 years from the WorldCom account, this accounting scandal should not be happen at all, as this will help the investor to making a better decision and save employee job in the future.

Arthur Anderson the big audit firm should not be able to miss such of the big amount of fraud that making by the top management as an auditor where is your responsibility to ensure that the audit report are represented with true and fair view. If the auditor are doing well of their job function and making a judgement based on actual evident this of fraud could be easily to be detect by them. If depend on you own ethical to be part it or not.