Accsys Technologies Plc - Risks of Impairment of Inventory, Goodwill and Intellectual Property - Example

AUDITING Introduction Accsys technologies PLC. is a loss making company. The losses have been reduced his year by 58% but still they have disturbed the company’s net assets (Accsys Technologies PLC 2013c). The net assets of the company have reduced by 10% from $61,493 mn in 2012 to $55,518 mn in Year 2013 (Accsys Technologies PLC 2013b). The company keeps foresees the challenges coming ahead. There are risks related to the business and financial results of the company which are illustrated below: Risks Of Impairment Of Inventory As the markets expand, the increasing competition may lead to the impairment of the inventory. The company’s accounting policy is to value the inventory at lower of cost or Net Realizable Value. Accsys has recorded the expense of $843,000 in year 2012 to being the inventory value down to net realizable value. (Accsys Technologies PLC 2013a) The risk involved with the inventory valuation is that most of the products of the Accsys are of customized nature. The market value of such products is difficult to be taken from the market. Moreover, since it is subject to subjectivity, the management may not be willing to disclose such matters especially in years of losses. The obsolescence and demand of the inventory can also be measured from the Inventory days in ratio: 2013 2012 Inventory $4,860 $3,120 Cost of sales $15,474 $15,050 Inventory in days $114 $75 This ratio shows that the inventory is taking more time to convert in cash this year as compared to previous years. This is an indication that the finished goods in stock are more prone to demand decreas,e which may lead to the obsolescence of the inventory (Norman and Alderman 2013). Risks of Impairment of Goodwill and Intellectual Property Accsys consists of $8.2 mn, which constitute 14% of the total net assets of the company (Accsys Technologies PLC 2013d). As per the financial review of the company much of the licenses are progressing towards completion. Though, achieving new business ventures has always been difficult, the directors are certain that the recoverability of the goodwill is not at stake. This statement of the management may be biased because company will not like to increase any further expenses. Moreover, intangibles include the development costs. Accsys development costs have increased to $861,000 in 2013 from $283,000 in 2012 (Accsys Technologies PLC 2013e). It is possible that the research expenses are capitalized so that the expenses are decreased and the position of net assets is made better. IAS 38 describes that the feasibility of the project should be taken in consideration before the research is capitalized (Graham, Abbas and Magnus 2006). The financial feasibility of the projects undertaken should be checked thoroughly. The company has been in losses for the last 2 years, dividends are not being paid and the cut in costs has also led to nil charitable donations. It seems that Accsys might not be financially healthy to support any new products. Impairment should be tested in detail. Risk Related to Joint Venture Accounting Unlike to the corporate governance structures of the companies, joint ventures are normally not subject to such restrictions and corporate governance requirements. Resultantly, the joint ventures are much at freedom as compare to other listed entities. As joint venture is not a listed entity, so its financial statements are also not required to be published. The Users (Joint venture parties) are the relevant parties to whom the audited financial statements are presented. This fact is crucial to the preparation of the financial statements of Accsys since the results of joint venture partially bring their impact in the financial statements of the company. The proportion of the financial results of TTL has to be considered in more detail. This joint venture may be used to transfer the losses and expenses of Accsys to the books of TTL. This way, Accsys will be able to reduce its costs. Joint venture’s financial position reflects that Current liabilities amount to 88% of the total Assets of the joint venture. (Current liabilities: $366 mn, Total Assets: $413 mn) (Accsys Technologies PLC 2013f). If joint venture suffers from further losses, assets may not be able to satisfy the liabilities. The impairment of the investment in the joint venture investment should be checked. Risk related to Foreign Currency Valuation Given the two facts that Accsys is suffering from losses and that it is going for any hedging indicates that there is risk of incorrect currency translation. This is possible because Accsys is already selling to more than 16 countries. As more currency valuations are involved in financial reporting, the risks for incorrect translation also increase. Incorrect rates may be applied that should not have been applied to that specific transaction. But all these risks are risks due to error. The company can also commit fraud by intentionally delaying the booking of the transaction at the date when the rates are higher (IFAC 2009). Risks related to Revenue Recognition There is a risk that the revenues and expenses have been window dressed in order to produce a gross profit. Accsys might be interested in showing this picture for presenting an argument that even the company has been loss for consecutive years, but this year has been in better position as the Gross Profit is much higher than the previous year. 2013 2012 Sales 18,822 13,574 The revenue has increased significantly in this year. It increased by 17%. This could be because of the increase in the license agreements. Since license agreements are billed on progress of completion basis, it is possible for the management to manipulate the results. The company may misinterpret the operational level progress when putting it in financial statements. The auditors are normally not aware of the operations of the entity and hence cannot check the progress of the license with reasonable assurance. The risks related to revenue are also increased due to the fact that all the license agreements’ revenue are accounted for as per individual agreement terms and conditions. There is no uniformity in the terms of the licenses. This way, revenue recognition has to be checked with respect to each agreement, which increases the detection risk. Such risk may arise because not every person has the skill to test the agreements in details. Procedures for Verification of Revenue The detailed audit procedures for gathering evidence at assertion level may be divided into two broad categories: Substantive analytical procedures Other detailed audit procedures Substantive Analytical Audit Procedure Geographical proportion of sales The substantive analytical procedures may include testing the sales data on the geographical basis (Kamal 2004). The geographical dispersion of the sales reveal the following data: Segmental Reporting Analysis of Revenue by geographical area of customers: 2013 2012 ‘000 ‘000 Variation Netherlands 6,182 5,264 17% United Kingdom 3,532 2,123 66% Switzerland 1,597 735 117% Germany 1,507 1,011 49% North America 1,458 1,006 45% Norway 764 307 149% Belgium 660 367 80% China 543 784 -31% India 459 231 99% Ireland 451 2,442 -82% Australia 419 129 225% New Zealand 333 49 580% Italy 228 147 55% France 201 121 66% Other 488 286 71% 18,822 15,002 25% Above data indicates significant variance in Switzerland, Norway, China, Australia, Ireland, and New Zealand. This analytical procedure has set the direction for further detailed testing. Now, primarily the sales from these countries will be checked in order to check that whether the sales recorded are classified accordingly in terms of geography or not. It might be possible that the sales are recorded appropriately but they are not correctly with respect to their geography. Moreover, this increase and decrease will bring its corresponding impact to the logistics expense. The ratio of logistics to sales on country basis should be computed for prior years. In order to enhance the assurance, this ratio should then be compared with the ratios of the current year. In case of variation, the reasons will then be inquired for with the management. Comparisons of Budgets with the Actual sales Accsys must have set its targets for selling goods. Such targets are reflected in budgets. The budgeted sales should be compared with the actual sales for each month. The reasons for the variation should be inquired with the sales department (Luis, Audit Procedures 2007). The reasons obtained should then be corroborated with other management comments and industry knowledge. The future action plans that were decided to increase the sales should also be sought and the implementation there upon should be checked. Such questioning assist in knowing the target areas of management of the company. If management was interested in selling goods to Switzerland then why was that so? If it was not interested in selling the goods in Switzerland, then how come sales increased? The overall planning throughout the year will come in front. At least, it will reduce the risk that the sales have been booked all of a sudden at the year-end to increase the revenue. Customer wise Analysis of Sales The customer wise break up sales should be obtained. Such break up should then be compared with the prior year’s break up of sales. Any significant variation should be inquired for with the management. There is a risk that the new customer is a dummy customer and fake invoices have been generated for that customer in order to increase the sales. The response to such risk is addressed below in detailed audit procedures. The customer wise break up should also be corroborated with the geographical sales data. The risky countries where sales increased exceptionally might have generated such sales because a significant customer might have shifted from one country to another country. Detailed Audit Procedures The detailed audit procedures are generally performed on sampling basis. The substantive analytical procedures conducted above set the direction for detailed testing. For instance, sales of Switzerland and other such countries whose sales increased will be tested in more details. The procedures that will be performed are discussed below: Tests for Occurrence For testing the occurrence, the sales transactions will be picked from the general ledger. Such transactions will then be traced back to the source documents such as Sales order, Delivery note, Dispatch note, Goods receipt note sent by the customer, and other correspondence that was exchanged with the customer (Luis, Auditing Procedures 2007b). The terms and conditions in the sales order and other agreements will be inspected. This is because any a times, there are late delivery charges imposed on the sellers which are not incorporated by them in the financial statements on the hope that customer will not deduct such amount. Tests for Cut-off Cut off tests are performed to ensure that the transactions of one period are not recorded in other period. Such test in normally performed by checking the last transaction of preceding period and the first few transactions of the proceeding period. In case of revenue, the invoices will be checked in order to ensure that the sales are booked as per the date of invoice. Moreover, the delivery notes will also be checked. As per IAS 18, date of delivery of the goods is the date when the risks and rewards are transferred. Goods that are delivered should be booked (invoiced for) in the same period. Cut-off tests also assist in ascertaining the completeness of the transactions. Tests for Accuracy For testing the accuracy of the transactions, re-calculation shall be performed of the invoice value. Tax computation and foreign currency translation should be checked. Tax rates can be verified from the income tax laws. Foreign currency rates could be verified from foreign exchange companies’ websites. It should be verified that the rates taken are of the transaction date. Tests for Classification There is a risk of misclassification as the revenue from license agreements have increased substantially by 637%. It is possible that revenue from other sources has been classified as license revenue. The license agreements should be read. The terms for license agreement will assist in identifying the revenue to be generated from license agreements. BIBLIOGRAPHY Accsys Technologies PLC. "Balance sheet - Annual report." March 31, 2013b. http://www.accsysplc.com/wp-content/uploads/2013/09/March-2013-Annual-Report-and-Accounts.pdf (accessed March 21, 2014). —. "Comprehensive income - Annual report." March 31, 2013c. http://www.accsysplc.com/wp-content/uploads/2013/09/March-2013-Annual-Report-and-Accounts.pdf (accessed March 21, 2014). —. "Financial Position - Annual report 2013." March 31, 2013d. http://www.accsysplc.com/wp-content/uploads/2013/09/March-2013-Annual-Report-and-Accounts.pdf (accessed March 21, 2014). —. "Notes to the accounts - Annual report." March 31, 2013a. http://www.accsysplc.com/wp-content/uploads/2013/09/March-2013-Annual-Report-and-Accounts.pdf (accessed March 21, 2014). —. "Notes to the accounts - Annual Report 2013." March 31, 2013e. http://www.accsysplc.com/wp-content/uploads/2013/09/March-2013-Annual-Report-and-Accounts.pdf (accessed March 21, 2014). —. "Notes to the Accounts - Annual report 2013." March 31, 2013f. http://www.accsysplc.com/wp-content/uploads/2013/09/March-2013-Annual-Report-and-Accounts.pdf (accessed March 21, 2014). Graham, Holt, Mirza Abbas, and Orrell Magnus. International Financial Reporting Standards (IFRS) Workbook and Guide. 1. New Jersey: Wiley Publications, 2006. IFAC. "ISA 240 - The Auditor’s Responsibilities Relating to Fraud in An Audit." December 15, 2009. http://www.ifac.org/sites/default/files/downloads/a012-2010-iaasb-handbook-isa-240.pdf (accessed March 19, 2014). Kamal, Gupta. Contemporary auditing. 1. Delhi: McGraw Hill Publications, 2004. Luis, Puncel. Audit Procedures. 1. Chicago: CCH, 2007. —. Auditing Procedures. 1. Chicago: CCH, 2007b. Norman, Godwin, and C Alderman. Financial ACCT2. 2. Mason: Cengage Learning, 2013. Appendix: Statement of Comprehensive Income Variation 2013 2012 Amount % Wood revenue 16,555 13,574 2,981 22% License revenue 553 75 478 637% Other revenue 1,714 1,353 361 27% Total revenue 18,822 15,002 3,820 25% Total cost of sales (15,474) (15,050) (424) 3% Gross profit 3,348 (48) Other operating charges (13,548) (12,497) (1,051) 8% Impairment of license receivable - (2,281) 2,281 -100% (10,200) (14,826) 4,626 -31% Share of joint ventures (430) - (430) -100% Finance income 206 154 52 34% Finance expense (244) (240) (4) 2% Loss before taxation (10,668) (14,912) 4,244 -28% Tax(charge)/credit (355) 536 (891) -166% Loss for the period (11,023) (14,376) 3,353 -23% Gain arising on translation of foreign operations 14 35 (21) -60% Total comprehensive income (11,009) (14,341) 3,332 -23% Statement of Financial Position Non Current assets Variation 2013 2012 Amount % Intangibles 8,226 7,579 647 9% Investment in joint ventures 62 - 62 100% Property, pant and equipment 22,271 25,614 (3,343) -13% Available for sale investments - - - 0% Deferred tax 866 1,522 (656) -43% 31,425 34,715 Current assets Inventories 4,860 3,120 1,740 56% Trade and other receivables 3,688 3,576 112 3% Cash and cash equivalents 20,467 24,574 (4,107) -17% Corporation tax 623 1,117 (494) -44% 29,638 32,387 Current liabilities Trade and other payables (3,357) (3,385) 28 -1% Obligations under finance lease (264) (264) - 0% Non Current Liabilities Obligations under finance lease (1,924) (1,960) 36 -2% Net assets 55,518 61,493 (5,975) -10% Equity and reserves Shares capital - ordinary shares 4,332 4,040 292 7% Shares premium account 128,588 124,887 3,701 3% Capital redemption reserve 148 148 - 0% Warrants reserve 235 82 153 187% Merger reserve 106,707 106,707 - 0% Accumulated loss (184,511) (174,415) (10,096) 6% Own shares (39) - (39) -100% Foreign currency translation reserve 58 44 14 32% 55,518 61,493 Read More