It is a dramatic notice, for sure. On September 4, state-owned fertiliser company Agritech announced that its external auditors KPMG Taseer Hadi and Co., had resigned. No explanation was given with this announcement. Then on September 7, the company issued another notice, this time to say that the board of directors would meet on September 9 to discuss this resignation.
This obviously leads to the burning question: why did the auditors resign?
To answer that, first we need to understand the nature of an audit. An audit is an external examination and evaluation of a company’s financial statements. Companies can have both an internal audit, and an external audit, usually conducted by a professional services network that specialises in accounting and audits. This audit is then included in the company’s reports, and its opinion can differ from the opinion put forward by the company’s chairman or board of directors.
Such was the case with KPMG and Agritech. Agritech manufactures and markets fertilisers under the brand name ‘TARA’. It has a urea manufacturing plant in Mianwali, Punjab. It also operates a manufacturing facility of GSSP (granular single super phosphate) at Haripur Hazara, in Khyber-Pakhtunkhwa.
Now, the last available financial statements of Agritech are for the nine months ending September 30, 2019. But the last audited report is the company’s annual report of 2018 (which was actually released in September 2019).
According to those financials, the company has made a loss every single year, between 2012 and 2018. The company made a loss after tax of Rs3,334 million in 2018, which was not as bad as 2017, when the company recorded a loss of Rs4,483 million, or as bad as 2014, when it recorded a loss of Rs4,303 million. In the nine month period ending September 30, 2019, the company had recorded a loss of Rs2,090 million. Its long term debt has hovered around the Rs19,300 million mark since 2012.
KPMG auditor’s report highlighted a couple of financial notes that it thought were concerning.
First, the company had unabsorbed tax losses of Rs6,060 million, and tax losses on account of unabsorbed depreciation amounting to Rs20,897 million. The company, somewhat ambitiously said that there would be ‘sufficient taxable profits in future tax years to absorb these losses is expected on the basis of a five year business plan.’ (We will get to this five year plan.)
Second, Agritech said there was no need for an impairment to be accounted for against the goodwill stemming from when the company Azgard Nine bought the entire company in 2006. This goodwill amount was Rs6,060 million.
The auditors had this to say: “Management has assessed the recoverability of deferred tax asset on tax losses and tested the impairment of goodwill based on five years business plan approved by the Board of Directors and asserts that no impairment is required. However, we are unable to obtain sufficient appropriate audit evidence with respect to key assumptions used in the business plan… Consequently, we were unable to determine whether any adjustments in respect of impairment were necessary for goodwill amounting to Rs2,567 million and deferred tax assets amounting to Rs6,060 million recognised on tax losses of Rs20,897 million in these financial statements.”
The auditors also pointed out that several financial institutions had sued Agritech, though it also said ‘our opinion is not qualified in this respect”.
It turns out that in 2018, Meezan Bank had sued Agritech for Rs40 million and Allied Bank had sued the company for Rs202 million. And there other suits pending as well: a contractor had claimed Rs840 million, (which was not counted as debt, because the company had filed a counter claim), Pak Libya Holding Company had filed a claim of Rs1,501 million, and several unquantifiable cases were pending in labour courts as well. Oh, and the National Accountability Bureau had opened up an inquiry against the owners and directors of the company.
On top of everything, the company’s liabilities exceeded its assets by Rs40,999 million, and its accumulated losses stood at Rs17,517 million.
This is why KPMG said: “These conditions, along with other matters … indicate the existence of a material uncertainty that may cast significant doubt about the company’s ability to continue as a going concern.”
Now, the management of the company responded to some of the auditors’ report. For instance, it pointed out that it had a rough time, saying, “the fact of the matter is that the gas curtailment coupled with gas pricing issue to the company’s urea plant has been the most crucial factor for the past few years’ operational and liquidity issues of the Company. The fertiliser sector as a whole and the Company in particular faced unprecedented gas curtailment during the last five years.”
According to the company, this gas curtailment was the major cause of its inability to pay even the interest on its debt, and the accumulation of interest further increased its debt burden. That is why the company started a Capital Restructuring Plan, to convert existing long term debt, including interest, into preference shares. This plan also includes selling excess land to pay off long term lenders.
“The infrastructure developments plans of the government of Pakistan around the Company’s both plants will likely to increase the value of its land. Particularly, the participation of the Company in [China-Pakistan Economic Corridor] CPEC project’s section Hakla-Daudkhel-DI Khan through provision of land for the said project looks very exciting and with the completion of CPEC, the surplus land of the Company has potential for commercial and industrial activities for CPEC related trades in the future.” Agritech noted optimistically.
This plan, by the way, was filed in the Lahore High Court in 2016, but hearings for it continued all the way to September 2019 (the last available financial report).
We bring up the audit report, and some other details, to give you a sense of where the company is headed (or was headed as of last year), and what the auditors seemed concerned about.
Profit asked Agritech why KPMG resigned. According to Shakir Sayid Ali, manager in the internal audit team of Agritech, KPMG was unable to audit the financials because of the Covid-19 pandemic. The pandemic caused a delay, and meant that fieldwork was unable to occur. According to Ali, Agritech had filed two extensions with the SECP, one in April, and the second in August. As the deadline for the second one is approaching (October 6), Agritech asked KPMG to expedite the process, but they were unable to. And that is why they resigned.
Profit also called KPMG’s Lahore office, which is handling much of the work associated with the Agritech audit, but despite repeated calls, was unable to receive an official comment from the firm. However, a source within the firm, while unable to speak specifically about Agritech, was able to generally speak about the KPMG’s attitude towards companies like Agritech.
Essentially, it boils down to this: it is actually very stressful to be an auditor for a Pakistani company. There are global reasons for this, and there are local reasons for this.
First global: The ‘big four’ firms in the auditing world are Deloitte, PwC, Ernst & Young, and KPMG. There used to be the ‘big five’: these plus Arther Anderson. In 2002, this firm had to surrender its license, after it was found guilty of fraud in auditing Enron. The energy company Enron had famously declared $100 billion on its financial statements through accounting fraud, and had pressured Arther Andersen to do so.
Even though Arther Andersen was able to get their conviction for financial fraud overturned in the United States Supreme Court in 2005, the reputational damage had already been done. It is a lesson to all auditors: that the liability as such of conducting an audit (unlike, say a feasibility report), is endless, because if an audit is wrong, and one is caught up in a company’s fraud, then anti-fraud law is not kind to accounting companies.
Second, local: there is immense pressure by the global heads of the accounting companies on their local Pakistani subsidiaries to apply an extra layer of scrutiny on Pakistani companies. Why? Because the world simply does not trust them. It is an unfair assumption perhaps, but it does explain why auditing companies are extremely wary of having textile or real estate companies in Pakistan as clients. It is simply too dodgy.
As another example, when the news of the Abraaj scandal broke, KPMG resigned as the auditors of the K-Electric (Abraaj had a 66.4% stake in the company). Simply being associated with a company like that was enough to prompt KPMG to resign.
The source thought it was extremely improbable that KPMG resigned because of the Covid-19 pandemic (calling the claim a ‘case of sour grapes’).
It would be a stretch to start comparing Agritech to companies like Abraaj: simply performing poorly is no indication of fraud. But the company has performed poorly for years now, and has a half baked still pending plan to get rid of debt. It is also likely under immense pressure to perform, and show better financials. It looks like KPMG wanted to steer itself away from any trouble – even a hint of it.