Outsoursing Fiasco - Mentara Bhd. is a family business that incorporated in 1995. The company is PDF

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Mentara Bhd. is a family business that incorporated in 1995. The company is involved in distributing a wide range of products including food and beverages, home appliances and garments. The founders of Mentara Bhd is Dato’ Ir. Johan Arshad and his wife, Datin Jasmin Karim. The company were formed du...

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1.0 BACKGROUND OF COMPANY Mentara Bhd. is a family business that incorporated in 1995. The company is involved in distributing a wide range of products including food and beverages, home appliances and garments. The founders of Mentara Bhd is Dato’ Ir. Johan Arshad and his wife, Datin Jasmin Karim. The company were formed during the time when many of companies were hit by financial crisis 1997 and 1998, the business was not seriously affected due to less reliance on borrowings and the company’s effective credit facilities with their suppliers. Besides, many of their supplier were local partners.

Due to that Mentara Bhd. become one of the leading hypermarket chains in Malaysia. By following to that, Mentara Bhd expanding its business operations and the company sought to be listed on Second Board listing on Bursa Malaysia during the year 2000. While with that status Mentara Bhd. enjoyed the benefits of fund raising and government incentives. Mentara Bhd. become one of the top 20 best performance listed companies in year 2005 and now Mentara Bhd. has a total of eleven branches operating in Peninsular Malaysia, as well as in Sabah and Sarawak.

2.0 MENTARA BHD

2.1 Factors that could influence effectiveness of Audit Committee at Mentara Bhd.

The audit committee has become an important sub-committee of the board, a corporation responsible for overseeing and governing the credibility of the reporting practices, auditing process and financial position of an organization (Blue Ribbon Committee, 1999). The board of directors will predominantly hand over financial activities to the audit committee, whereby its jurisdiction and formal procedures will examine the effective evaluation of the internal control procedures, reporting practices and financial position of an organization (Organization for Economic Cooperation and Development, 2004).

2.1.1 Audit Committee and its Responsibility The experience and understanding of the internal control process by the committee is important in helping and encouraging auditors to evaluate the state of the internal control system of the Mentara Bhd in such a way that the audit plans and methods can identify and reveal errors and fraudulent practices (Caplan, 1999). The formation of audit committees is related to strengthening the financial control of a Mentara Bhd, resulting in the financial process supervisory committee. The audit committee's responsibilities include investigating any matter within its jurisdiction, accessing the necessary resources to fulfill its duties, and having a direct channel of communication with both external auditors and internal auditors.

2.1.2 Audit Committee Meetings, Knowledge and Expertise

An audit committee can use the number of meetings it holds to determine its effectiveness. Financial statements users believe that the number of meetings held is an indication of the commitment and time required to oversee the financial reporting process of a company. An audit committee's significant objective is to give its members sufficient time to fulfill their role of driving and overseeing the financial reporting process of a company. The number of meetings held by an audit committee can be used to measure its effectiveness. Accounting and finance knowledge and experience are considered to be some of the most important elements of an effective audit committee. It is recommended to be experienced in accounting and finance by at least one member of the audit committee. This ensures the quality, reliability and credibility of the audit committee's oversight function.

2.1.3 Independence and Size of Audit Committee

The lack of independence in audit committees has resulted in a number of corporate fiascos and, as a result, the composition of the audit committee must be taken into account in order to achieve effective corporate governance systems. The independence of the audit committee allows effective monitoring of the activities of the executives as independent audit committee members can make objective decisions and do not require much discussion and

debate. The audit committee should be independent of its executives in order to carry out its supervisory function effectively. In Malaysia, it is required that audit committees are made up of not less than three members with a large number of the members being independent directors. An audit committee is considered independent if more than half of its members are independent. An independent audit committee helps to minimise the agency costs. In addition, Lin, Li, & Yang (2006) found that the quality and credibility of financial reporting is influenced by the audit committee's independence. In Mentara Bhd, another important feature that enhances its effectiveness is the size of the audit committee. The size of the audit committee is used to indicate the amount of resources available to it. The audit committee must have at least three members this is to enable its member to make a majority decision that is impossible if one or two members make up the committee.

2.2 Please list the appropriate actions that Menara Bhd. could undertake to overcome the weakness/ improve the effectiveness of its Audit Committee? Firstly, members of the audit committee must understand the reasoning behind the choices made by management and the implications for financial manipulation. All the directors should understand the business model and how the business makes money. But audit members need to understand how such transactions require management to make judgments and choices, including the selection and application by management of critical accounting policies, judgments and estimates, and the potential for manipulating financial statements. Critical accounting policies require complex, subjective judgment and critical accounting estimates that require uncertainty assumptions where different assumptions can have a material impact.There should be clear agreement that when an accounting treatment is open to interpretation or requires a judgment or has a material impact on the company's accounts, appropriate disclosure of the nature of this estimate should be made, e.g. its sensitivity or "fragility," based on the current management's judgment of future events being incorrect, in the MD&A, or the equivalent. Secondly, recruit, orient, educate and retire your audit committee members carefully. A comprehensive, formal and tailored induction should be provided to all new audit committee members, including committee charter, past agendas, papers, minutes and reports, key accounting standards and treatments, regulatory, risk and control framework, auditor and other

insurance provider work plans, and in-depth sessions with reporting management and auditors. To enhance their contribution to the audit committee, all audit committee members should receive and display commitment to continuing education on leading practices. Members should update or enhance their knowledge of relevant accounting, auditing, industry and other regulatory requirements through management briefings, auditors and subject experts, funded external offers and member preferential site visits. This last item, site visits, is particularly important as audit committees should actively visit the company's operations in order to gain insight into the control environment first hand. Moreover, have effective risk management oversight by the audit committee. The board, audit committee, and management should have a shared commitment to an effective risk management system, which means it is enterprise-wide, robust, integrated into operations, realtime, continuous, and culturally embedded, responding to, identifying, evaluating, monitoring, controlling, and mitigating the company's material business risks. This risk management system should enhance the review process undertaken by the audit committee, i.e., drive the internal audit plan, external audit process, insurance negotiations, and other business processes, e.g. identifying key risks and compliance obligations where independent assurance is required. Second, the audit committee should have a clear understanding of the scope of risk supervision. The risk profile established by the board should take into account the material business risks, financial reporting and otherwise identified by the company's risk management system, and the board should exhaustively and holistically allocate the oversight of such risks to itself and the board committees and should be adequately documented, including reporting and accountability within charters. The risk appetite for example acceptable amount and type of risk set by the board for each material business risk should be clearly articulated subject to review by the audit committee. Risks should be ranked, for example, and clear tolerance ranges and boundary limit indicators should set strategic management parameters, guide risk mitigation action, and inform the deliberations of the audit committee, as well as private sessions. Lastly, have a strong internal audit function reporting directly to the audit committee. The audit committee should seek to ensure that the internal audit head is independent of management and external audit and is objective in reporting factual findings to the committee. The internal audit head (including senior staff) should not engage in operational or non-internal audit or oversight transactions and should have direct access to the audit committee.

2.3 Discuss any auditor independence issue in this case and should Mentara Bhd appoint new external audit firm? (rotation of audit firm)

Independence was described as avoiding the situation that tends to impair objectivity or allow personal prejudice to influence sensitive judgment ( Carey et al.,1996). In particular, auditor independence implies the absence of influence or control over the conduct, action, and opinion of the auditor. It simply refers to the ability of the auditor to honestly and impartially express his conclusions. Under the Malaysian Accountants Institute (MIA) By - Law, independence requires both which is the independence of mind and independence in appearance (MIA, 2006). Independence in mind can be defined as the state of mind of the auditor and his / her ability to maintain a proper attitude in the planning of his / her audit program, the performance of his / her audit work and the preparation of his / her report.On the other hand, appearance independence (or perceived independence) refers to the perceptions of the independence of the auditor by the public or others.In order to be considered independent, an auditor should be able to demonstrate that his or her independence is not threatened so that an outsider would not doubt the objectivity of the auditor.

The first issues in Mentara Bhd. is appointment MAC & Co. as their internal auditor and also the external auditor. The audit staff who involve in internal audit work involved the same people who were involved in the audit of the financial statement of Mentara Bhd. It shows that the auditor was audit their own work back. Besides, MAC & Co do not have staff that has experienced staff in performed the internal audit services and qualification in that field. Furthermore, the same partner-in-charge for both external and internal prepared the internal audit report and submitted it to the Audit Committee. The consequence, there have self-review threat, poor quality of work and Mentara Bhd. incur an outrageous cost.

In selecting the appropriate service provider for the outsourced internal audit function, the Audit Committee shall consider the following qualities. First thing is about the audit firm itself, it must knowledgeable and competent in the areas to be audited. Second, the auditor must be appropriately qualified, experienced, and a member of The Institute of Internal Auditors.

Next, auditor who performed the internal audit must independent, objective, and free from any undue influence and no conflict of interest. Last but not least is regularly undertakes a quality assurance and improvement programme. But The Audit Committee in Mentara Bhd. does not see all this qualities before they want to appoint the outsourcing internal audit. Under section 139148 of Companies Act states that auditor is not rendering to provide internal audit services to the client.

There has a question on auditors to be prohibited from providing any services other than audit, to their audit clients. This is because of perceptions of the independence of the auditor by the public. Institute's ethical code forbids auditors to provide non-audit services to audit clients if that would present a threat to independence for which no adequate safeguards are available. The best decision that Mentara Bhd. can do is terminate the internal audit function which is MAC & Co. and the Audit Committee need to consider if Mentara Bhd. wants to outsource they must follow the qualities in the select of appropriate outsourced Internal Audit Function.

The second issue in Mentara Bhd. is absence in audit rotation. MAC & Co have been appointed as their external audit since the company incorporated in 1995 until 2007. It has been 12 years with the same auditor. This issue can create a conflict of interest and long-term association relationship. Consequences, there has the problem in self-interest threat and familiarity threat. Self-interest threat is the threat of an auditor acting in his or her own emotional, financial or other personal self - interest or commonly called a 'conflict of interest' which may inappropriately influence judgement or behaviour while familiarity threats are when you become so sympathetic to the interests of others as a result of a close relationship that your professional judgement becomes compromised.

An individual may not play an important role in an entity's audit for more than five out of seven consecutive financial years. Under MIA By-Laws states that an individual should not be a key audit partner for more than 5 years. Auditor independence is the main goal of audit firm rotation. Besides, corporate governance also states that audit committee must ensure that the independence and objectivity of auditor not compromised. The independence of the auditor will increase and the "fresh look" auditor will deal more appropriately with the financial reports.

When the lead auditor changes, they must "start from scratch" with their client, which means that there is no long-standing relationship intact through this can give impact to the audit quality.

2.4 Please list down the appropriate criteria for the recruitment and promotion of staff in Mentara Bhd.

Appropriate criteria for the recruitment of staff in Mentara Bhd as describe below :● Qualified staff- This is the very first criteria to considered because an employment manager with expertise in developing recruitment processes and proven management skills in leading recruiters and employment specialists is one such program model. Recruiters and employment specialists should have experience in full life-cycle recruiting, from sourcing candidates to post-hire functions such as orientation, training and employee retention. ● Legal Compliance - Functional expertise, qualified recruiters, job specialists and managers must have a good understanding of the law on equal opportunities for employment and, where applicable, affirmative measures. The success of an organization may depend on its ability to recruit qualified applicants from a diverse pool. Recruiters and job specialists therefore need to be familiar with laws, fair employment practices related to recruitment and hiring, and job eligibility. Recruitment and selection is the first opportunity for employers to express their commitment to equal opportunity. ● Pre-employment Standard - Background investigations, reference checks, verification of work history and screening of drugs are common standards for preemployment. Some industries and employment trends have a slight impact on criteria however, basic pre-employment standards function as checks and balances to ensure wise hiring decisions are made by an organization. Candidate testing is included among other criteria for consideration by human resources and employment managers. In some recruitment and selection programs, pre employment testing may be a viable consideration depending on factors such as positions, type of industry and cost to administer.

Appropriate criteria for the promotions of staff in Mentara Bhd as describe below :● Attendance - An employee must be at work and punctual, at a minimum, to be considered for a promotion. ● Performance. Does the employee fulfill their duties in a timely manner? Reviews of past performance will show how an employee performs in terms of their job responsibilities. If uncertain, an employee should seek their manager's feedback. ● Attitude- Is the employee easy to work with? It is essential, although this is less quantifiable. Does the staff work well with other staff and managers? ● Leadership- Skills in leadership. Does the employee show leadership skills? Are they learning fast and adapting to new responsibilities? How are they going to respond to challenges? Do they accept feedback and integrate it?.

2.5 Given the above scenarios, please suggest the appropriate method to establish the internal audit function in Mentara Bhd. Please draft a proposal to support your argument as to whether Mentara Bhd. should outsource or establish their internal audit function.

Internal audit is needed in every company to ensure the financial statement give true and fair view. Internal audit function responsibility is to monitor the performance of an entity’s control. The auditors need to acquire and understanding of the internal audit function before they do an auditing services. In order to plan an audit, the auditor must have sufficient knowledge regarding the auditing to ensure an auditor performed their task in a good manner. In Mentara Bhd., Dato’ Johan as a Chief Executive Officer (CEO) and Jalil as a Chief Financial Officer (CFO) has discussed regarding the establishment of the internal audit function. They agree to appoint Malik who are from the Sales Department to act as the new internal auditor without consulting with the Human Resource (HR) Department. In this case, Malik is not qualified as an auditor because he did not have background in accounting and auditing. As mentioned in paragraph 1, the auditor need a sufficient knowledge in audit scope to performed the good internal audit function but Malik do not have knowledge and working experience in auditing to take the role as the company’s internal auditor. Furthermore, Dato’ Johan supposedly

should discuss among the Board of Director to appoint someone to do a job as internal auditor but he only discuss with Jalil who is his brother. In order to establish internal audit function in Mentara Bhd., Dato’ Johan as a CEO and all the Board of Director need to think whether to outsourcing internal audit function or establish their own internal audit function. Outsourcing internal audit function is a hiring independent auditors to do an internal audit job process while establish internal audit function is a hiring employees to work on an audit work basically to those who has an expertise in audit scope. Audit Committee need to observe the comparison between outsourcing and establish their own internal audit function by looking at the pro and cons of both of it before they make a decision. Besides, both of this audit function has their own pro and cons that Board of Director of Mentara Bhd. need to aware before make a decision and conclusion to choose either one in doing internal audit function of company. In this case, after a discussion and serious consideration among the Board of Directors of Mentara Bhd., they agreed to outsource their internal audit function and move current internal audit which is Malik to his old department (Sales Department) and transferred Samantha to the Purchasing Department. Mentara Bhd appointed company’s auditor, MAC & Co to do the internal a...