QUESTIONABLE

ACCOUNTING PRACTICE

AIR ASIA BERHAD

CASE STUDY

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Contents 01 ISSUES OF AIR ASIA BERHAD

02 IMPACT OF NON CONSOLIDATION

03 SUBTANCE OVER FORM

04 INDEPENDENT AND ETHICAL CONSIDERATION

05 LEGAL VS EFFECTIVE CONTROL

Issues at AAB Berhad
 Issues at AAB
1. Report from GMT research states that AAB used transactions with its affiliate companies
to boost the company earnings. This issue was raised by the external auditor PWC.

2. Caused a drop in AAB share price drastically.

3. Using equity method as choice in accounting practice and wish to consolidate the
accounts but AAB is not allowed to do so due to regulatory reason.

4. Associates company, Indonesia and Philippines were making loss in their operations.
AAB comes up with plan to save the companies.

5. Air Asia depreciation policies which is seem to be aggressive when compared to other
aviation company. Annual depreciation rate of AAB was 3.6% vs its peers range at
4.5 – 6.3%
Impact of Consolidated
Financial Statement
 ENRON
Will AAB • Avoid consolidate the SPE and used off-balance-sheet
vehicles to take on large amounts of debt and fabricate

same earnings.
• Enron to avoid consolidating the financials of these SPEs,
each SPE had to meet three criteria.

with 1. Outside investors have to have at least 3% ownership

2. General partner of the SPE has to have control of the
SPE in such a way that it does not act on behalf of

Enron? the sponsor

3. SPE must possess the lion’s share of the risks and
rewards of ownership
• Enron typically used the Equity Method of accounting for
SPE’s
• Added Enron’s proportional share in the earnings of
each SPE in a single line item on its income statement
without disclosing corresponding balance sheet, cash
flow and other consideration
 Equity Method vs Consolidation
Equity Method (Current practiced by AAB)
• Equity method does not combine the
accounts in the statement, but it accounts for
the investment as an asset and accounts for
income received from the subsidiary
• Company A is entitled to a portion of
Company B's earnings in proportion to
Company A's economic ownership of
Company B's stock, even if these earnings
were never paid out as dividends
• Intercompany transaction of operations is
deemed to be revenue of the company.
Text ere
Consolidation Method (Plan to apply in AAB)
• Consolidating the financial statements
involves combining the firms' income
statements and balance sheets together to
form one statement
• Eliminate and exclude the internal sales
and purchases from the group figures
• The parent’s investment in each subsidiary
is offset against the parent’s portion of
equity of each subsidiary.
Text Here
 Opinion
The financial presentation of AAB is more “healthy” if using
Equity Method instead of Consolidation

Add Text
Revenue
RM1.1 billion in lease and
other income will be
eliminated in full from
statement of financial
performance if AAB
consolidate the account.
Subsequently, profit of AAB
decreased
Complete
Financial
Overview
Performance
get a complete overview of
Combining the Indonesia
the parent company. At a
AirAsia & Philippines
glance, they can view the
Airasia will deteriorate the
overall health of the
profit of AAB as the loss
business and how each
cannot be proportion to
subsidiary impacts the
Company AAB ownership
parent company.
and need to incur full loss
from associate.
If you holding a substantial share in the company, will
you do something that less likely benefit to yourself ?

• To maintain and build

public image of Tony
Fernades and AAB

• To prevent the
investors panic sell the
AAB share

• To prove they have the

initiative to consolidate
the account and wish
fulfillment
 EQUITY METHOD
The financial presentation of AAB is more benefit from
Equity Method instead of Consolidation

Revenue
Revenue from association .
Substances Over Form
 DEFINITION
Substance over form is an accounting concept which means that the economic
substance of transactions and events must be recorded in the financial statements rather
than just their legal form in order to present a true and fair view of the affairs of the entity.

Substance over form concept entails the use of judgment on the part of the preparers of
the financial statements in order for them to derive the business sense from the
transactions and events and to present them in a manner that best reflects their true
essence. Whereas legal aspects of transactions and events are of great importance, they
may have to be disregarded at times in order to provide more useful and relevant
information to the users of financial statements.
 The principle of Substance over legal form is central to
Substances the faithful representation (true and fair view) and
reliability of information contained in the financial
Over Form statements.

By placing the responsibility on the preparers of the

v.s financial statements to actively consider the economic
reality of transactions and events to be reflected in the
financial statements, it will be more difficult for the
preparers to justify the accounting of transactions in a
True and manner that does fairly reflect the substance of the
Fair View situation.

However, the principle of substance over form has so

far not been recognized by IASB or FASB as a distinct
principle in their respective frameworks due to the
difficulty of defining it separately from other accounting
principles particularly reliability and faithful
representation.
 AIRASIA BERHAD
• AAB had recorded all the financial information based on substance over form.

• All the relevant information have been audited Audit Committee to ensure integrity of published
financial statements, they stated that GMT would not have been able to carry out such analysis of
the business if there were insufficient disclosures in AAB’s audited and quarterly financial
statements.

• Even AAB had a whole series of meetings with PwC, legal advisers, management of the Associate
companies and aviation regulators to effect consolidation of its Associate companies and AAB
believe it can be allowed to consolidate its associate companies, because with the rights to
variable returns from its involvement with its Associate companies.

• But in fact, power in practice is not a legal control, PwC has however taken the strict interpretation
of power in MFRS10 (Consolidated Financial Statements Accounting Standard) and advised that
AirAsia cannot consolidate its associates companies because it does not have legal power.
 AIRASIA BERHAD (conts..)
• Therefore contrary to the GMT report that AAB did not want to consolidate its Associate
companies, they were actually compelled not to consolidate as a result of the opinion of their
Auditors. Any change in the present relationship with the Associate companies, be it in equity
shareholdings or Shareholders Agreement, that gives AAB legal control will result in loss of the
Associates’ Airline Operating Licenses.

• Due to AAB’s inability to consolidate, it presented full disclosure of the Associate companies
financials and also its operating statistics, as given in the Quarter1 2015 announcement, for
stakeholders to have information on the performance and financial position of the Associate
companies.

• In conclude, the reason AAB does not consolidate its associates to provide true and fair view is
because of the aviation regulation in the foreign country, AAB have been advised to do so would
be a breach of MFRS 10 and in addition the ‘true and fair’ override would also not be allowed.

https://www.thestar.com.my/business/business-news/2015/06/22/airasia-audit-
committee-issues-statement-over-gmt-research-report/
 Kaplan Financial Bank
True and fair override

IAS 1 states that an entity whose financial statements comply with IFRSs
should disclose that fact.

However in extremely rare circumstances management may conclude that

compliance with an IFRS or interpretation would be misleading.

In this case an entity should depart from the requirement of the standard
provided the relevant regulatory framework permits such departure.
Independence &
Ethical Consideration
 Independent
Who should be independent?
• Independence Non-Executive Director
Independent  Dato’ Fam Lee Ee
 Mr Utaya Kumar
 Dato’ Mohamed Khadar Merican
• External Auditor-PWC

Why should be independent?

1. Independents are impartial
An independent board member’s job is to look out for the well-
being of the company and the shareholders’ interests first.
2. Independents want to be there
An independent board member can bring focus and depth of
perspective about your industry, company.
3. Independents bring expertise to bolster where you have
room to grow
Better to listen, advise and counsel to the BOD of company
4. Independents are the key to conflict resolution
Be a bridge builder in difficult conversations.
5. Independents can mentor and share their network
The independent board member needs to have a network of
contacts to assist or enhance these needs
 Ethical Consideration
• GMT Research report that AirAsia is creating profits and operating cash flow by abusing its associates,
especially in Indonesia and Philippine.

• AAB group structure looks designed to remit profits and cash at the operating level to the parent
company from airline associates.

• Allows AirAsia to pad up its financials but comes at the expense of the associates

• For example : AirAsia generated RM603 million from leasing aircraft to its associates and another
RM466 million in other income from activities such as selling aircraft to them at a profit in financial year
2014.

• This is an unethical consideration by AAB.

• AAB associates,
Text ere
particularly Indonesia AirAsia (IAA) and Text Here
AirAsia Philippines (AAP), are loss making
and have exhausted their shareholders equity.
Legal vs Effective control
 Legal vs. Effective Control
LEGAL CONTROL
• The parent company has a legally enforceable
right to direct the actions of a subsidiary.
• The legal control based general consolidation
policy does not give much discretion to corporate
groups while making consolidation decisions.
When ownership of a majority of voting stock
exists, the subsidiary must generally be
consolidated
• Legal control standard enables corporate group
to avoid the consolidation of inconvenient
subsidiaries by using other means the ownership
of a majority of voting stock to control their
Text ere
business.
EFFECTIVE CONTROL
• Effective control means that in addition to the
legally enforceable means of control, economic
means of control are considered while making
decisions whether to consolidate or not consolidate
a potential subsidiary.
• Effective control is a characteristic that can be
determined only by subjective decision making and
line drawing. Such subjective decisions by
accountants of different corporate groups inevitably
result in different interpretations of the
consolidation policies.
• Effective control standard for general consolidate
Text Here
policies when a parents can control its subsidiary
and direct it assets and liabilities.
 Legal vs. Effective Control
Must IAS 27
50 %? CONCEPT OF CONTROL

Ownership of more than 50% of voting

power. Control is exist when the parent Unless, in exception circumstances, it can
owns directly or indirectly through be clearly demonstrated that such
Who subsidiaries, more than one-half of the ownership does not constitute control
said? voting power of an entity

IAS 27 is principles-based, and all evidence must be considered for

the existence of control

- Legal ownership is the only criterion for determining the existence of control (>50%)
Text ere Text Here
- Power to govern operating financial policies
- Obtain benefits from activities of the other entity.
 AIRASIA BERHAD
AirAsia Berhad Case:
•Audit committee of AAB issues a press statement
addressing the alleged accounting gimmick.
• AAB cannot have legal control or legal power over
its Associate Companies due to aviation regulation in
Indonesia, Philippines, Thailand and India
• Any change in AAB present relationship with
Associate Companies be it in equity shareholder or
agreement that give AAB legal control will result
loss the Associates’ Airline Operating Licenses.
Opinion/Suggestion:
•Associate company is a company which another
company own a significant portion of voting share
20%-50%.
•AAB unable to consolidate associate company
because have no legal control or power against it
associate company
•So, Air Asia Berhad does not to consolidate the
associate financial statement.
•So that, the associate value in AAB is reported in the
balance sheet as an asset,, the investor’s proportional
share of associate’s income is reported in the income
statement and the dividend from ownership decease the
value of the balance sheet.