15

C A S E 2
Asian Journal of Case
Research
4(S): 15 25 (2011)
Flat Cargo Berhad: An Auditors Conundrum
ZAKIAH MUHAMMADDUN MOHAMED
a*
AND
TAKIAH MOHD ISKANDAR
b
ABSTRACT
Flat Cargo Berhad (FCB) was one of the largest air freight companies
in Malaysia, servicing several government linked companies including
Freight Malaysia Berhad, and had Kencana & Associates served as
its auditors. In 2006, during a routine fnancial audit, the auditors
identifed several suspicious fndings that resulted in a delay in
fnalising the auditors report. The case presented an auditors dilemma
involving the possibility of fraud in a fnancial audit engagement.
Keywords: fraud, auditors, professional scepticism
INTRODUCTION
It was 5 February 2006 and Mr Chuah Mun Soong had just fnished a meeting with
his audit team. He was silently enraged. Not another Media Com or Blue Vital.
Could there be a fraud in Flat Cargo too? he wondered. His frm, Kencana &
Associates, could not deal with another client scandal. He had just been informed
by his subordinates that there had been inconsistencies in the accounts of Flat
Cargo Berhad (FCB). His team was to report to the audit committee of FCB in
two weeks. His boss, Mr Keong Chee Wah, the managing partner of Kencana &
Associates, had to be informed immediately of the situation.. Taking time to calm
himself down, Mr Chuah decided to work through the companys information to
assess the possibility of fraud. He needed the information to help him explain the
situation to Mr Keong.
COMPANY BACKGROUND
FCB was a listed company operating primarily as an air cargo carrier. It was
registered as an investment holding company with several subsidiaries. The
principal activities of FCB subsidiaries included air freight services and aircraft
a
School of Accounting, Faculty of Economics & Business, Universiti Kebangsaan Malaysia
b
School of Accounting, Faculty of Economics & Business, Universiti Kebangsaan Malaysia
*
Corresponding author: E-mail:zmm@ukm.my
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Asian Journal of Case Research (AJCR)
ground handling services. FCBs wholly owned subsidiaries included FC Spare
Sdn Bhd, Cargo Management Sdn Bhd, FCB (SPV), Cargo Air Services Sdn Bhd
and FC Air Ltd. The companys head offce was located in Selangor.
FCB started operations in 1997 with two aircrafts: a Boeing 737-200F and
a Cessna Grand Caravan. FCBs maiden fight in November 1997 had been an
overnight air express transport service for Freight Malaysia Berhad to Singapore.
Flat Cargo Group obtained listing in Bursa Malaysia
1
on 15 September 2001.
FCBs major shareholder in 1997 had been Bangor Berhad, which was part
of a diversifed international family owned conglomerate, the Miri Group. The
Miri Group had a China based company called Miri Logistics Ltd which owned
logistic businesses extensively in the Asian region. In 2004, the Miri Group
2

bought a controlling interest of 55.2 million shares or 26.5% of FCB from the
founders, Lim Loon Sim and Ali Bin Ahmad, via an off market deal.
The fast growing intra-Asian air express market fuelled FCBs expansion
plans between 2001 to 2004. With the extensive growth in e-business activities,
the demand for express transportation services increased. FCB aimed to maintain
their niche position in the Asia Pacifc region by delivering best quality customer
service and satisfying customer demands. The corporate structure of FCB is seen
in Figure 1.
Figure 1 Flat Cargo Group Berhads corporate structure
Main Activities
FCB was the only dedicated Intra-Asian overnight express cargo operator based
in Malaysia. Its core business was to provide air freight transportation, which
included aircraft charter and leasing.
FCBs prompt handling of large shipments to meet customer demands was
attributed to its expansion in freighter feet size for its Boeing 737s, 727s, MD11s.
In addition, it had access to an international cargo complex covering 24-hour
custom facilities at the Sultan Abdul Aziz Shah Airport in Subang. If it had not
1
Formerly known as the Kuala Lumpur Stock Exchange (KLSE).
2
The Miri family owned China -based Miri Logistics and had strong interests in the transportation and
logistics business and presence in most parts of Asia.
17
Flat Cargo Berhad: An Auditors Conundrum
been for the scandal, FCB would have likely remained as the nations leading air
cargo carrier.
With an array of landing rights in the Asia Pacifc region, FCB was in the
ideal niche position to offer express air services to international integrators,
freight forwarders and major airlines within the Asian region. It managed to
secure major landing rights in various countries in Asia including China, Japan,
Thailand, Singapore, India, Indonesia, Taiwan, Sri Lanka, the Philippines, Korea,
Myanmar and Cambodia.
FCB Customers
Up to 2005, FCB secured agreements with well-established companies such as
Worldwide Express, United Parcel Services (UPS), Nationwide Express, Citylink,
Bax Global and Nippon Express. Cargo Malaysia Services and Bangor Berhad,
being FCB major shareholders, also used FCBs air freight forwarding services.
FCB offered regular fights to fast growing countries like China, Thailand and
India. Other destinations in the region included major cities in the Asia Pacifc
region.
Governance Structure in FCB
The Chairman of FCB was Dato Ibrahim Samad who was also an independent
non-executive director of the company. He was the former Director General for
the Ministry of Transportation. He was also Malaysian Chamber of Commerces
former President.
The top management team comprised of Mr Lim Loon Sim as the Chief
Executive Offcer, Mr Ali Bin Ahmad as the Executive Director, and Mr Kim Boon
Chok as the Chief Financial Offcer. Mr Lim Loon Sim was the founder for FCB
and had been a board member since 1997. As at 31 December 2006, he owned
6.5 million shares in FCB, worth approximately RM97.5 million valued at RM15
per share. Mr Ali Bin Ahmad, who had been a board member since 1999, held
30,000 shares in the company. He was also the chairman of the companys Audit
Committee and a member of its Employee Share Option Scheme Committee.
As shown on Appendix D, the Board of Directors comprised of two
independent non-executive directors and six non-independent directors, of which
three were executive directors and the remaining non-executive directors. The
composition of the Board of Directors was in adherence to the Malaysian Code
of Corporate Governance (See Appendix E). The Audit Committee of FCB
consisted of three members.
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Asian Journal of Case Research (AJCR)
The director shareholdings of the company by 31 December 2005 were as
follows:
Directors Number of ordinary shares of
RM1 each as at 31/12/2005
Lim Loon Sim 65,500,000
Ali Bin Ahmad 30,550,000
Lee Guan Choi 10,550,000
Miri Kim Chen 120,750,000
Dato Ibrahim Samad 6,187,000
FCB Financial Growth
In 2005, FCBs counter was ranked 4th in terms of capital gains and dividends to
shareholders. Its share price at 31 December 2001 had been RM1.89, but by end
of 2005, the share price surged to RM10.60 per share. It was reported that FCB
had been able to pay dividends at a steady 3% per annum for over 4 years.
Turnover for 2005 was RM550 million, which is more than 1 times than that
for 2004 (see Appendix A). Analysts were expecting FCBs revenue to increase
for the next year by a further 54% to RM809 million because of its major capacity
expansion in 2005 despite the rising fuel prices. FCB also acquired several new
aircrafts, namely MD-11s and two B727s, and projected to secure additional
landings rights in China.
Despite the rave reviews made by various investments houses, FCBs high
gearing, nevertheless, posed serious concerns. Rating Agency Malaysia (RAM)
rated FCBs RM150 million Commercial Papers or Medium Term Notes to AA3/
P1 and downgraded the companys long term rating from stable to negative. The
rating was due to the companys high gearing ratio and weak debt servicing ability.
Excerpts from FCBs Audit Working Papers for 2005
Audit working papers for 2006 revealed the following:
The auditors were unable to verify the aircrafts claimed to have been purchased
by FCB in 2005. The audit team found a non-functional rundown aircraft
barely worth RM231 million in a hangar.
Several debtors confrmation letters were returned because the addressees had
changed their mailing addresses.
A large sum of sales transactions was found with no supporting documents.
Most of these transactions involved small clients.
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Flat Cargo Berhad: An Auditors Conundrum
A loan received from a Hong Kong based company was found to be incorrectly
recorded in the debtors account.
Several abnormal transactions involving the purchase of aircrafts by FCB and
offsetting the debtors accounts were found in FCBs books.
THE AIR CARGO INDUSTRY
The industry is described as highly competitive with low proft margin. There are
about 85 operators servicing all over Malaysia and the Asia Pacifc region. The
major players in Malaysia include MAS Cargo Sdn Bhd, a subsidiary of Malaysia
Airlines Bhd, Malaysias national carrier.
The growth rate for the air cargo industry had been about 21.3% per year
from 1991 to 2003. However, the International Air Transport Association (IATA)
reported that there was to be a mere 3% growth for the international freight traffc
in the Asia Pacifc region for 2005.
In 2005, an international crisis occurred with the exceptional increase in
oil prices. The hike started in mid-2004 at US$40 per barrel but eventually, the
increase continued to stages of US$50, US$60, US$65, US$70 and US$80 per
barrel. The price hike in fuel surcharges drastically affected the freight forwarding
industry signifcantly because of its reliance on fuel for operations.
CONCLUSION
Mr Chuah decided to consult his frms legal department for advice as he was not
willing to risk his frms reputation because of a client. The report prepared by
his audit team was going to be presented to FCBs audit committee in a few days.
Meanwhile, he convinced himself that FCB was a reputable company with a good
business model and the possibility of irregular activities in FCB was remote.
REFERENCES
Business News (2005, November 5). Asias Air Cargo Industry Struggles with Continued
Fuel Surcharges, Retrieved October 15, 2010 from http://www.prweb.com/
releases/2005/11/prweb306197.htm
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Asian Journal of Case Research (AJCR)
APPENDIX A
FCBs Financial Statements from 2001 to 2005
Income Statement
2001 2002 2003 2004 2005
RM000 RM000 RM000 RM000 RM000
Revenue 180,692 219,278 289,169 346,180 550,078
Operating expenses (13,336) (13,177) (14,035) (16,829) (429,943)
Other income 604 1,012 456 1,187 11,274
Proft from operations 44,571 51,347 72,700 97,642 131,409
Interest expenses (10,924) (7,896) (7,605) (8,543) (21,510)
Income from associated
companies & other
investments
57 (2,706) (2,579) 425 491
Proft before tax 30,941 43,508 65,526 86,620 110,390
Taxation (3,657) (3,993) (16,388) (24,227) (35,543)
Proft after tax 27,284 39,514 49,464 62,393 74,847
Balance sheet
2001 2002 2003 2004 2005
RM000 RM000 RM000 RM000 RM000
Non-current assets:
Land & buildings,
plant & equipment
336,733 445,519 475,443 595,072 1,565,807
Goodwill 1,161 1,113 1,064 1,015 966
Investments in associated
companies
532 588 13,528 1,176 13,263
Long term investments 18,782 18,782 11 18,792 20
357,208 466,002 490,046 616,055 1,580,056
Current assets:
Work in process 684 - 14,168 5,313 12,568
Debtors 88,509 75,129 72,392 105,771 111,113
Other receivables 66,498 34,125 39,261 202,959 79,770
Cash in bank 10,877 30,524 31,638 165,240 261,235
166,568 139,778 157,459 479,283 464,686
Less current liabilities:
Creditors 28,914 24,086 23,147 24,302 58,463
Other payables 41,141 42,062 32,467 61,119 64,613
Loan & overdraft 71,289 50,766 48,043 44,316 27,939
Provision for taxation 5,873 8,422 3,183 1,075 2,561
147,217 125,336 106,840 130,812 153,576
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Flat Cargo Berhad: An Auditors Conundrum
Net current assets 19,351 14,442 50,619 348,471 311,110
Total 376,556 480,444 540,655 827,754 1,891,166
Financed by:
Share capital 93,251 149,918 157,884 201,072 233,537
Reserves 135,859 137,749 164,526 427,995 700,916
229,110 287,667 322,410 629,067 934,453
Reserves attributable to
potential shareholders
- - - - 15,659
Total owners equity 229,110 287,667 322,410 629,067 950,112
Non-current liabilities
Long term loan 143,892 188,400 173,694 131,242 833,474
Deferred tax 3,554 4,377 44,551 67,445 107,580
147,446 192,777 218,245 198,687 941,054
Total 376,556 480,444 540,655 827,754 1,891,166
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Asian Journal of Case Research (AJCR)
APPENDIX B
Fleet Information for FCB Group
Aircraft type Confguration Delivered Status Exit date
Boeing 737-275C(A) Cargo 01-04-1999 Active
Boeing 737-248C Cargo 26-03-1994 PT-MTA TAF
Linhas Aereas
17-09-2000
Boeing 737-230C Cargo 24-02-1995 PT-MTA TAF
Linhas Aereas
01-08-2002
Boeing 737-2X6C(A) Cargo 15-03-1996 N747AS
Alaska Airlines
16-02-2001
Boeing 737-209(A)(F) Cargo 02-12-1996 Active
Boeing 737-209(A) Cargo 15-01-1997 N827AL
Aloha Airlines
19-06-1998
Boeing 737-275C(A) Cargo 15-01-1997 Active
Boeing 727 Cargo 01-05-2005 Active
Boeing 727 Cargo 01-08-2005 Active
McDonnell Douglas
DC-10-30
Cargo 13-02-1998 N831 LA
Virgin Express
10-08-1998
McDonnell Douglas
DC-10-30
Cargo 25-02-1998 N833LA
Laker Airways
05-1998
McDonnell Douglas
MD-11F
Cargo 26-04-2005 Active cvtd MD-11
McDonnell Douglas
MD-11F
Cargo 12-04-2005 Active cvtd MD-11
McDonnell Douglas
MD-11F
Cargo 10-06-2005 Active cvtd MD-11
McDonnell Douglas
MD-11F
Cargo 21-07-2005 Active cvtd MD-11
Source: www.planespotters.net
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Flat Cargo Berhad: An Auditors Conundrum
APPENDIX C
5 year Group Financial Highlights
2001 2002 2003 2004 2005
Net proft 20,531 21,869 38,107 45,463 84,369
Total assets 523,985 605,780 653,934 1,088,909 2,044,742
Total shareholders funds 229,110 270,903 322,410 629,067 950,112
Paid-up shares in issue
(000)
93,251 149,918 157,884 201,072 233,537
Net tangible assets per share
(RM)
2.46 1.81 2.04 3.13 4.07
Earnings per share
(cent)
14.90 14.50 24.50 25.10 38.50
Gross dividend per share 3.00 3.00 3.00 3.00 3.00
Source: Flat Cargo Group Annual Report 2005
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Asian Journal of Case Research (AJCR)
APPENDIX D
Board of Directors
The list of FCBs Board of Directors:
Director Role
Dato Ibrahim Samad Chairman, Independent Non-Executive Director
Lim Loon Sim Chief Executive Offcer, Non-Independent
Executive Director
Ali Bin Ahmad Non-Independent Executive Director
Lee Guan Choi Non-Independent Executive Director
Miri Kim Chen Non-Independent Non-Executive Director
Tan Sri Rahim bin Fahmi Non-Independent Non-Executive Director
Datuk Abu Bakar bin Sharif Non-Independent Non-Executive Director
Sulaiman bin Ahmad Kamil Independent Non-Executive Director
Chong Kee Kit Independent Non-Executive Director
Audit Committee
Audit Committee members as reported in FCBs 2005 Annual Report:
Chong Kee Kit (Chairman)
Ali Bin Ahmad (Member)
Sulaiman Bin Ahmad Kamil (Member)
Top Management Team
Lim Loon Sim (Chief Executive Offcer)
Ali Bin Ahmad (Executive Director, Employee Share Option Scheme Committee
Member)
Low Boon Wah (Chief Financial Offcer)
Source: FCB Annual Report 2005
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Flat Cargo Berhad: An Auditors Conundrum
APPENDIX E
Relevant Information on Corporate Governance in Malaysia
In Malaysia, the practice of corporate governance is governed by the Malaysian
Code on Corporate Governance (hereforth known as Code) which was frst
issued in March 2000. It codifes the principles and best practices of good
governance and describes optimal corporate governance structures and internal
processes. The reporting of compliance with the Code has been made mandatory
to all Malaysian public listed companies (PLCs). Thus, shareholders and the
public are able to assess and determine the standards of corporate governance of
those companies.
The Code was revised in 2007. The key amendments to the Code are aimed
at strengthening the Board of Directors and Audit Committee, and ensuring that
they are to discharge their roles and responsibilities effectively. The eligibility
criteria for the appointment of directors and the role of the nominating committee
are clearly spelt out in the amendments. Similarly, the eligibility criteria for the
appointment of audit committee members, the composition of audit committee,
the frequency of meetings and the need for continuous training are defned. In
addition, the amendments require all PLCs to set up internal audit functions.
In order to maintain independence, the Code specifes that the board should
include a balance of executive directors and non-executive directors (including
independent non-executives) as one of the key principles of corporate governance.
This principle is important so as no individual or small group of individuals can
dominate the boards decision making. To further strengthen the independence
of the board of directors, PLCs must adhere to the principle that there should be
formal and transparent procedures for the appointment of new directors to the
board. There must also be a formal and transparent procedure for developing the
policy on executive remuneration packages of individual directors. The details of
the respective remunerations must be contained in the companys annual report.
An audit committee is established by the board of directors to carry out
certain duties including the appointment of the external auditor, the co-ordination
of the external audit work, the review of fnancial statements and internal audit
functions, and the continuous engagement with the senior management of the
company. The Code requires that an audit committee must comprise at least three
members, a majority of whom are independent. All members of the committee
should be non-executive directors. The committee is required to meet regularly.
The details of the activities of the audit committee, the number of audit meetings
held in a year, the attendance details of each director with respect to meetings,
and the attendance details of the relevant training attended by members should be
disclosed in an informative way.
The Code clearly specifes that external auditors should independently report
to shareholders in accordance with statutory and professional requirements and
independently assure the board on the discharge of its responsibilities.