Financial Management of James Cropper Company - Essay Example

James Cropper Plc College Table of Contents 0 Introduction………………………………………………………………….3 2.0 Areas of High Audit Risk…………………………………………………….3 2.1 Revenue…………………………………………………………………………..3 2.2 Value assessing…………………………………………………………………..3 2.3 Pension……………………………………………………………………………5 2.4 Other payables and financial derivatives…………………………………….6 3.0 Why the financial derivatives are a heightened audit risk……………………6 4.0 How to reduce the audit risk………………………………………………….8 5.0 Reference list…………………………………………………………………10 1.0 Introduction James Cropper plc is a company that specializes on making fine paper in the U.K. Its main operational bases are in the U.S.A, Italy, Switzerland, Germany and China. Its head office is located in Burneside, UK. The company is listed on the Alternative Investment Market of the London Stock Exchange. James Cropper plc has a financial year end of 31st March. 2.0 Areas of High Audit Risk 2.1 Revenue. Revenue is the first area may well increase the audit risk in financial statement, and the reason that why I consider it is following: 1.The Group turnover for the financial year 2012/2013 stood at £79,241,000 which represented a 1% rise when compared to the previous financial year statement. The U.K market was also one of the company’s best performing market with a 4% rise in sales even though its export sales recorded a 1% contraction when compared to the previous financial year. Overall group data reported that sales into the U.S.A market rose by 24% whilst the European market indicated a 12% decline. The company’s overall profitability was assisted by the strengthening of the US dollar when compared with the sterling pound during this period. 2. The company’s profit before tax stood at £2,052,000 in 2012/13 when compared with 2011/12 whereby it stood at £843,000 before the IAS 19 pension adjustment. The main expenditure stood at £555,000. The other expenses were £228,000 which was mostly related to executive transition costs. Looking at their major products, Technical Fiber Products had an operating profit standing at £1,450,000 compared to 2011/12 when it stood at £629,000. Their turnover figures grew by about 6% on the preceding year’s turnover figure of £12,599,000. Sales in the Defense and Aerospace sectors represented an 18% and 20% of the overall sales respectively. The sales of TFP into the U.S.A increased by 16% and 17% in US dollar and Sterling terms respectively. The U.S.A represented the TFPs most important market with which accounted for about 55% of its turnover while it stood at 50% over the preceding year. It was however not so rosy in when looking at the same sales out of the U.S.A which shrunk by about 6%. The company took several steps aimed at consolidating the US operations. It closed the Cincinnati facility in mid-2012 while it will take until the third quarter of 2013 for the new facility at Schenectady to achieve to several consumer programs. The Schenectady facility needed an investment about US$3million initially. In conclusion, there is heightened audit risk in revenue area. 2.2 Value assessing. Value assessing for TFP and the Specialty Papers is a heightened audit risk area. And the reasons that why I consider it is following: 1. According to the annual report, the company is undergoing major re alignments in its principle market in the U.S .The closures of the Cincinnati plant and future closure of the Stratford facility after the accreditation of the Schenectady facility which has already required a huge investment of US$3million. 2. The specialty paper’s operating profit for the 2012/13 financial year stood at £697,000 which was significant drop when compared with the £1,430,000 that was reported over the preceding financial year. Overall turnover fell by 3% to stand at £57,699,000. There was also no sign of the improvements in the export markets due to the economic uncertainties that were present in many of its principal export markets. The U.K market however helped to ease the burden by expanding at a rate of 3% on the back of a 10% contraction in the export markets. The prices of its major raw material which is North Bleached Softwood Kraft (“NBSK”) wood-pulp fluctuated over the 2012/13 period. The price stood at US$840 per ton at the beginning of 2012 but dropped to US$770 per unit ton by 30th June 2012 and later hot up by the end of the financial year to stand at US$830. It had however risen to a high of US$855 by the end of May 2013. So in the area of value assessing, there are possible to increase the audit risk. 2.3 Pension. The group operated two funded pension schemes that provided benefits to about 40% of its employee workforce. The scheme’s assets’ overall value appreciated by about 6.3% over this period but the liabilities to the scheme appreciated at the same time by about 9.1%. According to an IAS19 valuation as at 30th March 2013, it revealed that the schemes had a total deficit of almost £10,353,000 compared to the previous year which showed a deficit of £7,698,000. This was a significant increase of about £2,655,000. The discount rates used were the main cause of the increase in the scheme’s liabilities. The rate applicable in March 2012 stood at 4.95% compared to 4.65% that was used in March 2013. This reflected the reduction in corporate bond yields over this period. Benefits for active members have been reduced as from 1st April 2011 to the effect that future raises in pensionable salaries have been restricted to RPI of up to a maximum of 2% per year. The next valuations will occur with effect from 1st April 2013. These fluctuations in yields and discount rates in the Company’s pension schemes which affects a significant percentage of it e employee work force is presents a significant audit risk. 2.4 Other payables and financial derivatives The trade and other payables under the account of current liabilities are reduced from £2.612 million in 2012 to £2.499 million in 2013. James Cropper plc as a world- class enterprise; it must have significant economic issues in every country. And because of the international exchange rate is change every day, the amount of the trade and other payables is change with the international exchange rate.. So this is a possible area to increase the audit risk. 3.0 Why the financial derivatives are a heightened audit risk 1. The characteristics of the financial derivative instruments increase the risk of its audit. Financial derivative instruments are based on the contract of sale or transactions contract, the rights and obligations of two sides of transactions would have been identified after signing of the contract, but the transaction has to at some point in the future to complete, it suggesting that financial derivative instruments has the characteristics with uncertainty and high risk. The type of financial derivative instruments increasingly, and some species which through the designed may avoid the regulatory from internal control. (Karla Johnstone, Audrey Gramling, Larry E. Rittenberg, 2013, p219) There will certainly cause an increase on audit risk. According to the James Cropper plc financial statement, the company’s asset value in terms of government and corporate bonds stood at 26% and 26% respectively in 2012 while it went down to 0% by the end of the 2013 financial year. This dramatic change will pose a significant audit risk. 2.Information asymmetry increased audit risk. Enterprises just need to pay a small deposit to sign a big contracts or swap the different types of derivative financial instruments within the transactions because the derivative financial instruments has the high- profit and high-risk characteristics. If the transaction is properly, the enterprises will obtain the profit amount several times more than the original net investment; conversely, it will bring a huge loss to enterprise. If the enterprise always put the huge money to do the transaction, it is bad for the normal operating. And in the British Airways case, the loss on derivative financial instrument obviously caused by operation fails. And such transactions are often carried out in the off- balance- sheet, in consideration of its own reputation and economic interests, enterprises might be provided to the auditors or audit institutions of incomplete and even fake information, which will increase the risk of audit. 3. The complexity of measuring the fair value of derivative financial instruments also increases the risk of its audit. The tense of the derivative financial instruments is the future, because it is a contract required two sides to complete the transaction at a certain time in the future or cancel the transaction through the forecast of the trend of changes in interest rates, exchange rates, stock prices and other factors by two sides of transaction. Compared with the traditional spot transactions, derivative financial instruments all need to complete the transactions at a certain time in the future, from signing the contract to the contract completed, the price of the financial instruments may has a dramatic changes. Therefore, measuring the fair value of derivative financial instruments is very complex; it also increases the risk of audit. 4.0 How to reduce the audit risk Audit procedures and specific applications of derivative financial instruments should including the following aspects: 1. Understanding the internal control and the control environment of the enterprises, and collect the transaction information and documents about the derivative financial instruments. To analysis the derivative risk of material misstatement and design the counter measures and take the further audit procedures for the identified material misstatement.(K. H. Spencer Pickett, 2011, p176) 2. Do the audit to the area which exist heightened audit risk according to the existing internal auditing information. (Iain Gray, 2011, p95) And identify the weaknesses of control according to the development of the enterprises key business process. 3. Carry out the substantive audit procedures related to assertions. A. Existence. Substantive procedures for existence assertions about financial derivatives instrument is include: 1. Confirm the holder and counterparties of the derivative financial instruments. 2. Checking other related agreements and other forms of documents. 3. Inspecting the supporting documents for the follow-up inspecting after the report period. 4. Observation and inquiry. B. Rights& Obligations (Ownership& Control). Substantive procedures for Rights& Obligations assertions about financial derivatives instrument is include confirming significant terms with the holder of, or counterparty to, the derivative; and inspecting underlying agreements and other forms of supporting documentation, in paper or electronic form.(Ray Tricker, 2005, p96) C. Completeness. Substantive procedures for completeness assertions about financial derivatives instrument is include: 1. Require the holders or counterparties of the derivatives financial instruments to provide all the detailed information about the transactions and derivative financial instruments with the entity. 2. Sending zero-balance confirmations to potential holders or counterparties to derivatives to test the completeness of derivatives recorded in the financial records (Ray Tricker, 2005, p107) 3. Checking the statements of broker about the existence of derivative financial instruments. 4. Checking the transaction information which confirmed by counterparties but do not meet the transaction records. 5. Checking the unresolved reconciliation account. 6. Inspecting agreements, such as loan or equity agreements or sales contracts, for embedded derivatives (Ibid, 2005, p109) D. Valuation. Substantive procedures for valuation assertions about financial derivatives instrument is include: 1. Inspecting the documentation about purchase price. 2. Confirm the holder and the counterparty of the derivative. 3. Inspecting the credit of counterparty of the derivative transaction. 4. Obtaining evidence to confirm the measure of the derivatives fair value or disclosed at fair value. 5.0 Reference list Ray Tricker, ISO 9001: 2000 Audit Procedures, 2005. Karla Johnstone, Audrey Gramling, Larry E. Rittenberg, Auditing: A Risk-Based Approach to Conducting a Quality Audit, 2013. Iain Gray, Stuart Manson, The Audit Process, 2011. K. H. Spencer Pickett, The Essential Guide to Internal Auditing, 2011. BAKER, H. K., & RIDDICK, L. A. (2013). International finance : a survey. Oxford, Oxford University Press. VALLABHANENI, S. R. (2013). Wiley CIA exam review. Hoboken, N.J., Wiley. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&AN=542838. OREGAN, D. (2004). Auditors dictionary terms, concepts, processes, and regulations. Hoboken, N.J, Wiley. Read More