Evaluation of Directors' Action

In order to evaluate whether the directors’ decision to negotiate with the auditor not to qualify financial statements was ethical, we use Traditional 5-Question Approach. Traditional 5-Question approach, as the name suggests, involves the examination of a proposed decision by asking 5 questions which are:

i. Is it profitable?

ii. Is it legal?

iii. Is it fair?

iv. Is it right?

v. Is it sustainable?

Below is the analysis of the directors’ decision through the 5 questions:

Is it profitable?

When the auditor was reviewing the company records, he discovered some deficiencies in internal control and accounting procedures and had made some recommendations to the company for further improvements. The recommendations suggested were to implement a Standard Operating Procedure - a set of approved guidelines showing steps to be followed for each activity, provide non-reconciled payments and collections totaled RM150,000 for year 2004 and RM250,000 for 2005 respectively in Profit & Loss Accounts, and to reconcile or write-off overstated cash and bank balances (RM40,000 for year 2004 and RM30,000 for year 2005) to Profit & Loss Account. If the directors negotiated with the auditor to produce an unqualified audit report and did not follow the auditor’s recommendations, it can be stated that the decision would lead to a profitable position for the company because revenue was overstated and expenses were understated.

Is it legal?

The directors’ action was seen to be illegal because it violated the Companies Act 1965 and Code of Business Conduct and Ethics for Directors. First, under Section 174(2)(a) of Companies Act 1965, it states that an auditor shall state whether the accounts are in his opinion properly drawn up in accordance with the provisions of this Act so as to give a true and fair view of the company’s affairs and in accordance with the applicable approved accounting standards. Thus, it clearly violated the duty of an auditor if the...