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Last updated: January 25, 2013 3:24 am
Two of the world’s top accounting firms helped conduct due diligence last year for Caterpillar’s $886m acquisition of ERA, the Chinese mining equipment maker that was later alleged to have accounting irregularities.
Deloitte and Ernst & Young conducted due diligence for the transaction, according to two sources close to the deal. Deloitte audited the working capital for ERA, while Ernst & Young conducted overall due diligence, one of these people said.
Caterpillar said last week it had discovered accounting irregularities at ERA, prompting it to take a goodwill impairment charge of $580m – more than half the value of the acquisition. The US machinery maker said it had found “deliberate, multiyear co-ordinated accounting misconduct” at ERA that was designed to make the company appear more profitable ahead of the acquisition.
The involvement of two of the Big Four accounting firms in Caterpillar’s acquisition of ERA is the latest illustration of the problems they have faced in China, where they are accused by investors and regulators of failing to catch systematic fraud at a series of companies with overseas listings.
Oliver Meng Rui, professor of accounting and finance at the China Europe International Business School in Shanghai, said the allegations made by Caterpillar about ERA highlighted the challenges of the traditional due diligence process, under which accounting firms check the books of a target company but typically do not check its underlying assets or business model.
“Sometimes it is difficult for them [accountants] to verify the accuracy of the numbers provided by executives,” said Mr Rui. “In cases of intentional fraud, the traces will be covered.”
Over the past two years, as a wave of fraud allegations has swept over dozens of China-based companies that are listed overseas, several of the world’s best-known accounting firms have found themselves embroiled in legal battles relating to the charges. In December, the US Securities and Exchange Commission charged the Chinese affiliates of five leading accounting firms with violating securities law after they refused to produce paperwork related to fraud investigations at nine Chinese companies.
Caterpillar’s regular auditor is PwC. ERA’s regular auditor was RSM Nelson Wheeler, a Hong Kong accounting firm that is part of RSM International, the world’s sixth-largest network of accounting firms. RSM Nelson Wheeler declined to comment.
Deloitte said it “was not involved in any due diligence pertaining to working capital” but declined to comment further. Ernst & Young declined to comment on or confirm its involvement with the Caterpillar-ERA acquisition.
ERA is a manufacturer of hydraulic roof supports used in Chinese coal mines, and it listed on the Hong Kong stock exchange through a reverse merger in 2010. In 2010, its most profitable year, ERA reported profit of HK $135m. In 2011, it reported a loss of HK $14m, according to the annual report it filed to the Hong Kong Exchange.
Additional reporting by Neil Munshi in Chicago and Ed Crooks in New York
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