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PwC sheds some light on Best World's financial affairs in interim update
BEST World International may have understated the sales and expenses relating to its China franchise business in 2018, with some 20 per cent of sales proceeds going into other bank accounts instead, its independent accountant said in an interim update published late Sunday night.
The nine-page interim preview from PricewaterhouseCoopers Advisory Services is part of a larger review into the financial affairs of mainboard-listed premium skincare products seller Best World, after concerns were raised over its sales practices as well as that of its China franchisees in February last year.
The review is at an advanced stage, PwC said on Sunday, though it still needs access to outstanding information and documents before it can complete its work.
For instance, PwC said it is currently studying the cash flow movements in those bank accounts that received 20 per cent of the sales value of goods sold by Best World. PwC did not state who these other bank accounts were held by, except that they were not in the name of Best World (China) Pharmaceutical Co, Ltd (Hunan Branch), also known as BW Changsha, the subsidiary that has operated Best World's franchise model since June 2018.
Best World's managers have told PwC that the 20 per cent difference mainly represents trade rebates due to its franchisees under an "oral arrangement", but PwC has not been able to independently verify this arrangement against any third-party supporting documents.
PwC added that the outflows from these other bank accounts include commission payments to members, payments to staff and transfers to Vicstar Lifestyle Pte Ltd.
Vicstar is owned by two individual shareholders who are the spouses of two of Best World's top Singapore distributors. According to contracts seen by PwC, Best World has provided Vicstar with information technology (IT) services, business management and personnel support since 2012 in return for a service fee.
As part of the IT services, Vicstar was given the right to use Best World's customer relationship management (CRM) system. This is a sales ordering system which tracks all product sales made and computes the commission earned and payable to each distributor.
Vicstar maintained the China customer database, facilitated the calculation of commissions due to distributors, and helped organise trainings and events for China distributors, PwC said: "We are in the process of performing further work to determine the circumstances surrounding Best World’s business relationship with Vicstar... We are also in the process of performing further work on Vicstar’s cash flow movements."
PwC said that the net financial impact of understating Best World's revenue and expenses in China "may not be significant", but added that the practice "may not be appropriate from an accounting perspective".
PwC said: "While this is not part of the scope of the independent review, we have recommended that the board work with the group’s auditors to review and consider if any reclassification or adjustments are necessary to the financial statements for the year ended Dec 31, 2018. We understand that Best World's auditors are reviewing these findings. We have also recommended that the board seeks a formal legal opinion on the legal and regulatory implications of the potential understatement and the arrangement in relation to the proceeds in the other bank accounts not in the name of BW Changsha."
PwC has also been tasked with investigating Best World's relationship with Changsha Best, its biggest customer and primary import agent in China until Best World switched from an “export” to a “franchise” model in June 2018. (PwC has since noted that the manner in which sales are conducted and commissions paid through Best World's customer network is the same under both models.)
Changsha Best is owned by the brother-in-law of Best World’s chief executive Dora Hoan. Although Changsha Best was active between September 2015 to June 2018, PwC said: "We were informed that records prior to FY2017 were not available as the company had moved to a smaller premise and these records were not kept.
"For FY2017 and FY2018, we were provided with cash flow movement spreadsheets and were able to trace these movements on a sampling basis to Changsha Best’s bank statements which we obtained independently. However, we were not able to trace these cash flow movements to any underlying source documents as these were not available."
Examples of underlying source documents would be third-party documents that support inflow of funds, like sales orders, third-party delivery documents, or payment vouchers supported by vendor or distributor invoices evidencing nature of payments.
As an alternative, PwC looked at Changsha Best’s sales data recorded on Best World's CRM system, and was able to obtain a sampling of sales orders from Changsha Best's distributors that matched the sales orders in the CRM system.
However, PwC found that Changsha Best's bank statements only recorded about 60 per cent of the value of its sales to distributors and customers during this period. Proceeds from the remaining 40 per cent of its sales had been deposited into other bank accounts. Some of these accounts were the same ones that were later involved in distributing trade rebates when BW Changsha took over.
PwC said: "These monies were then subsequently used for commission payments to distributors/customers, sales incentives and transfers to Vicstar. We are in the process of tracing the cash outflows from these bank accounts. We will report on our findings on the cash flow tracing once we have completed our work."
PwC's interim update has also thrown more light on how Best World's 33 Chinese franchisees operate.
PwC observed: "Contrary to the franchisee agreement where a franchisee is required to maintain complete and accurate transaction records, the franchisees we visited do not appear to have standard book-keeping practices and do not maintain complete financial and sales records."
Based on its scheduled site visits to eight franchisees and four more “surprise” unscheduled visits, PwC observed that the franchisees’ offices do not operate as retail outlets, and were generally located in buildings with restricted access and limited customer traffic during opening hours.
Rather, the premises are used to host pre-organised training events or seminars and product demonstrations. They also serve as collection points for customers to pick up their purchases, though franchisees do not have a warehouse to keep stocks and minimal stock is maintained at their premises, PwC found.
As outlined in March last year, PwC's mandate requires it to conduct targeted reviews on the sales and purchase records of the franchisees, review the physical flow of Best World's inventory to franchisees, and perform stock takes on inventory of franchisees on a sample basis.
Based on its sampling, PwC found that some 111.8 million yuan (S$22.8 million) of undelivered goods were sitting in a third-party warehouse as at Dec 31, 2018, even though these goods had been recorded as sold and paid for by Best World members. These goods were subsequently delivered in 2019, PwC noted.
The accounting could reflect sales cut-off errors, PwC said: "We have recommended that Best World’s auditors review the quantification and consider if any adjustments ought to be made to the sales and inventory numbers for the financial year ended Dec 31, 2018."
In response, Best World's management said that it has performed a subsequent review of all sales to franchisees and estimates that the value of undelivered goods as at Dec 31, 2018 is lower, at about 54 million yuan. Pwc said it is currently in the process of reconciling the difference.
Separately, PwC has also recommended that Best World seek advice from a suitably qualified Chinese law expert on whether its franchise model as currently structured complies with local China regulations, taking into account PwC's findings.
PwC is expected to report its full findings to the Singapore Exchange later this year, though no firm timeline has been shared. It had initially targeted to get the findings out in early February before running into various delays.
PwC wrote on Sunday: "Due to the incomplete information/documents of Changsha Best, there are certain outstanding matters and further work that is required with regard to Best World’s business relationship with the import agents in China and their sales/transactions with its distributors and customers. Additional work is also required to verify the cash movement during the export model and franchise model period.
"We understand that Best World's management is currently working with their subsidiary in China to facilitate the retrieval of the necessary information and documents."
In a separate statement, Best World said that its auditors are in the midst of reviewing PwC's interim findings: "The company will continue to work with its auditors and legal advisers on the matters raised."