Tuesday, September 22, 2015

Deloitte Malaysia failed to properly account for 1MDB's cost of options, understates losses by at least RM3.24 billion

The Wall Street Journal (WSJ) reported on Thursday that US$993 million, which was allegedly paid to International Petroleum Investment Corporation (IPIC) by 1MDB to buy back the latter’s options, has not been properly accounted for.  The options were granted to IPIC in 2012 to acquire up to 49% of its two energy subsidiaries, Powertek Investment Holdings, and 1MDB Energy (Langat) Sdn Bhd, as part of the condition for the provision of a guarantee by IPIC for US$3.5 billion of 1MDB bonds.

The above exposé raises another question of Deloitte Malaysia’s professionalism when auditing the accounts of 1MDB in 2013 and 2014.

The International and Malaysian Financial Reporting Standards 2 (IFRS2) states strictly that any “share-based payment requires an entity to recognise share-based payment transactions (such as granted shares, share options, or share appreciation rights) in its financial statements”.

In essence, 1MDB paid for the services of IPIC with the options to acquire shares in the former’s subsidiaries.  IPIC on the other hand, provided the “service” of guaranteeing 1MDB’s US$3.5 billion bond issue.  Therefore, the “cost” of these options granted to IPIC must be accounted as an expense in the financial statements.

Deloitte is fully aware of the granting of the above options to IPIC since 2012.  Surprisingly however, the audit firm failed to expense or provide for the cost of the options in the audited accounts for 2013 or 2014.

Worse, by November 2014 when Deloitte signed off the accounts for 1MDB’s March 2014 financial statement, the audit firm was already aware that 1MDB had paid at least US$993 million to terminate or buy back these options from IPIC.  This means that Deloitte would have been aware that the options granted to IPIC in exchange for the US$3.5 billion guarantee were worth at least US$993 million.

Therefore, a proper audit would have reflected the US$993 million expense in the profit and loss statement of 1MDB.  In other words, 1MDB, as audited by Deloitte, severely under-declared its losses by a massive RM3.24 billion based on the then exchange rate of RM3.26 to the US Dollar.   The true losses in the 2014 Financial Statement should read a whopping RM3.9 billion instead of just RM665 million.

However, IPIC also disclosed in its December 2014 Financial Statement that 1MDB still owes an additional US$481 million for the termination of the options.  If the above is also true, then the total losses will be even bigger at RM5.5 billion for 2014.

How can Deloitte, an international auditing firm, make such a massive blunder by failing to account for the massive options expense as required by IFRS2, adopted by the Malaysian Accounting Standards Body (MASB)?

The failure to conduct its audit of 1MDB in a professional manner did not only result in severely understated losses.  Deloitte’s failure also meant that not many people were able to see through how ridiculous the agreement was with IPIC, where 1MDB had to pay at least US$993 million to IPIC to secure a US$3.5 billion loan.

That represented an unbelievable 28.4% cost to 1MDB, on top of more than 9% paid to Goldman Sachs for arranging the bonds.  Such onerous terms are even worse than those of loan sharks in Malaysia.  Such a transaction, which must be approved by the Prime Minister or Finance Minister himself, must ring the loudest alarm bells and must be investigated thoroughly by all relevant authorities to uncover the culprits behind the scene.

The above only reemphasizes my earlier call for the 1MDB Board of Directors to convene an emergency Board Meeting to appoint a independent auditor to conduct a special review and audit of 1MDB’s 2014 financial statements.  The 1MDB Board must place the interest of the ultimate stakeholders’, the ordinary rakyat, first and not continue to the role to cover up the single biggest scandal of Malaysia’s history.

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