• SFP replied that consideration shares issued to acquire SFP Automation Sdn. Bhd. were valued at RM0.10 per share since shares issued to acquire SFP Technology Sdn. Bhd. from related parties were also valued at RM0.10 per share.
  
• My follow-up question regarding whether the acquisition of SFP Technology Sdn. Bhd. was done at market terms, however, was not picked up by the management.
  
• Due to the absence of written disclosure on valuation method for consideration shares issued and the recognition of a gain on bargain purchase of SFP Automation Sdn. Bhd., I have decided to forward my inquiry to the Malaysian Institute of Accountants.

Nearly one year after its debut on Bursa Malaysia, SFP Tech Holdings Berhad (SFP) had its first post-listing annual general meeting (AGM) held online on 7^th June 2023. This represented my first opportunity to inquire about the company’s valuation method of 41,790,000 ordinary shares issued as a consideration to acquire SFP Automation Sdn. Bhd. (SASB) [renamed from EST Exhibit Automation Sdn. Bhd.], regarding which I had multiple questions held since last year. My short engagement with the management during the AGM is elaborated in the beginning of this write-up, which is followed by a description of the technical challenges in filing a complaint with the Malaysian Institute of Accountants (MIA) regarding this case, and ended with a speculation on how the fair-value disclosure might have played a role in SFP’s share price-discovery process.

The questions and answer(s)

To ensure smooth conversations during the AGM, I structured my inquiry into two parts that comprised three questions. My first two questions revolved around the valuation method of those consideration shares and the reason for not disclosing it, as given below:

“Referring to p.114 and 140 of annual report, SFP acquired SASB for consideration of RM4.17 mil that was satisfied by 41.79 mil ordinary shares valued at RM0.10 each. Paragraph 37 of MFRS 3 mentions that considerations transferred should be measured at fair value, and paragraph B64(f)(iv) requires disclosure on the method of measuring fair value. May I know what is the method of valuing the aforementioned ordinary shares of SFP at RM0.10 each and why is it not disclosed in financial statements?”

Anticipating possible replies, I prepared two versions of my third question. Should management reply that the fair value of those consideration shares was based on the value pegged to shares issued to acquire SFP Technology Sdn. Bhd. (STSB), my third question would focus on whether this related-party acquisition was done at market terms, as follows:

“This is a follow-up to my previous question about the valuation of shares transferred as purchase consideration for SASB. Since STSB was owned by a related-party, the transaction price of RM0.10 per ordinary share of SFP for acquiring STSB may represent the fair value of SFP's shares only when there is "evidence that the transaction was entered into at market terms," as per paragraph B4(a) of MFRS 13. Could the management provide support that the acquisition of STSB was done at market terms?”

On the other hand, should the management quote willing-buyer-willing-seller as their basis of valuing consideration shares, my third question would be based on the concept of fair value, as elaborated below:

“This is a follow-up to my previous question about the valuation of 41.79 mil shares transferred as a purchase consideration for SASB. "Willing-buyer-willing-seller" may not suffice for determining fair value since paragraph 2 of MFRS 13 mentions that fair value "is a market-based measurement, not an entity-specific measurement." Could the management provide a better explanation on how the market/other parties would have valued SFP at RM0.10 per share when the transaction was entered into?”

No thanks to poor internet connection, I unfortunately could not catch the management’s reply on the reason of not disclosing the valuation method, or whether did they reply to this question. Nonetheless, their justification of valuing those consideration shares at RM0.10 per share fell within my expectation, namely it was based on the value pegged to shares issued to acquire STSB. I hence posted my follow-up question accordingly, but it was not answered during the AGM.

Choosing my scapegoat

Since the AGM could not satisfy my curiosity, I decided to, again, turn to MIA for clarifications. Not being a member of MIA who could submit technical inquiries, I unfortunately must assume that there had been a breach of MIA By-Laws or non-compliance with accounting/auditing standards by a member of MIA and lodge a formal complaint against the member accordingly.

The first challenge lay in identifying the member of MIA against whom I should lodge my complaint. My first choice was obviously the chief financial officer (CFO) who usually makes the statutory declaration on the correctness of financial statements, but SFP’s 2022 financial statements were signed off by the company’s managing director who is not a member of MIA, which made a complaint against the CFO (who is a member of MIA) awkward. My next choice would be the person who took my question during the AGM, if (s)he happens to be a member of MIA, but I could not identify the respondent to my question due to audio-only replies and the absence of self-introduction by the lady respondent.

Given reasons above, I fell back on the external auditor from Grant Thornton in choosing my scapegoat. As per Companies Act 2016, the auditor who signs off the auditor’s report on a company’s financial statements must be a member of MIA, hence membership is not an issue. The challenge lay in arguing that the auditor had not fulfilled his duty in obtaining a reasonable assurance about whether SFP’s financial statements were free from material misstatement, defined in paragraph 5 of International Standard on Auditing 200 as follows:

“As the basis for the auditor’s opinion, ISAs require the auditor to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Reasonable assurance is a high level of assurance. It is obtained when the auditor has obtained sufficient appropriate audit evidence to reduce audit risk (that is, the risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated) to an acceptably low level. However, reasonable assurance is not an absolute level of assurance, because there are inherent limitations of an audit which result in most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive. (Ref: Para. A30–A54)”

While debatable, two facts could cast doubt on the sufficiency of audit works done. First is that SFP has not disclosed the valuation method of consideration shares as clearly required by paragraph B64(f)(iv) of MFRS 3. And more convincingly, paragraph 36(d) of the same standard calls for a reassessment of the procedure used in measuring the fair value of considerations transferred before recognising any gain on bargain purchase, which is the case for SFP’s acquisition of SASB, hence there is little reason for the non-disclosure of valuation method.

To argue for the materiality of the issue complained, I elaborated on the potential direct impacts of a miscomputed fair value of those consideration shares in question. These included a 5.3% profit inflation caused by the gain on bargain purchase, and unknown impact on the amount of asset and equity recorded on SFP’s balance sheet. Due to space constraint, I ended my complaint with only these arguments.

The potential role of fair-value disclosures in SFP’s share price-discovery process

While I believe that my explanations on the potential impact of a miscomputed fair value would sufficiently support an investigation by MIA, the significance of the fair-value disclosure in question might be greater than what I have stated amidst the specific circumstances surrounding the case at hand.

Usually, the fair value of consideration shares determined by publicly-listed companies does not play a greater role other than as an input to compute the number of shares required to fulfil purchase considerations. This is because the figure is roughly fixed based on the traded price of existing shares which reflects the fair value of identical shares to be issued. The pecking order of having to refer to the existing market price first is given in paragraph 38 of MFRS 13.

However, the case of SFP is unique since the fair value of consideration shares for acquiring SASB is meant for the acquisition date on 18th March 2022, which was disclosed before the company’s listing date on 20^th June 2022. Without prior traded prices to rely on, market participants could have referred to the fair value disclosed, even though it represents only pre-acquisition value, in SFP’s prospectus in forming their opinions about the true value of the company’s ordinary shares and designing their trading strategy for the first day of share listing. This implies that the disclosure per se, regardless of its amount, is likely a material information, as described in paragraph 2.11 of the Conceptual Framework for Financial Reporting:

“Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports (see paragraph 1.5) make on the basis of those reports, which provide financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity’s financial report…”

In any case, I have submitted my complaint on 30th June 2023 and it is now pending response from the auditor before being investigated by MIA. Given that I have missed the opportunity to study acquisition accounting in school, I believe that any outcome from my complaint will provide a good learning experience for me, although I hope that the process will not take as long as my previous complaints for which I have yet to receive any update from MIA since they commenced investigation nine months ago.

*This post is a follow-up to my previous post titled “SFP Tech Holdings Berhad – An Inquiry Into Its 66.7%-Discount on Pre-IPO Shares Issued.”

*For a recent example of how Malaysian publicly-listed companies value their unlisted equity instruments issued as considerations for acquisitions, see the independent valuer’s report on shares of Rahman Hydraulic Tin Sdn. Bhd. – an unlisted subsidiary of Malaysia Smelting Corporation Berhad – that was issued to purchase Asas Baiduri Sdn. Bhd. on 4^th July 2022, although the valuation method adopted (income approach) is only one of the two methods prescribed in paragraph 38(c) of MFRS 13.

P.S.: SFP has made the minutes of its question-and-answer session publicly available at  https://disclosure.bursamalaysia.com/FileAccess/apbursaweb/download?id=138081&name=EA_GA_ATTACHMENTS.

P.P.S.: SFP has added an explanation in p.110 of its 2023 annual report that the fair value of RM0.10 per consideration share was based on an independent expert's valuation report which adopt the market approach.