Audit Risk Analysis of Scapa Group PLC - Case Study Example

Scapa Group PLC. Scapa Group PLC. Introduction Scapa Group PLC is a giant group that manufactures different products. It has decided to expand its customer base. Therefore, new acquisitions like Webtec are taking place. The company has decided to abandon its dormant subsidiary; Georgia subsidiary. The acquisition and disposal heighten the risks for auditing of Scapa Group PLC. Following are the risks identified: Over-Valuation of Assets related to European markets Although Scapa Group PLC says that there is no significant difference in balance sheet value and the net realizable value, yet it should be investigated with professional skepticism (Scapa Group PLC, 2013). Scapa Group PLC is exposed to risk in European markets. Sales in Europe declined by 7.5% (Scapa Group PLC, 2013b). This was mainly because of the tough competition by the French automobile products. Scapa Group PLC already resorts to hedging for covering against the commodity price fluctuation risk. There is risk that due to competition, the value of the products decline. Moreover, due to poor economic conditions, it is possible that many of the customers in European markets are not able to pay their debts (EU Business, 2014). The trade receivables in Europe constitute around 50% of the total receivables. The provisions for the bad debts should be considered in detail. There is a risk of debts not being recovered. Consolidation Issues With Respect To Webtec Scapa Group PLC has gone through major changes in group structure during this year. There has been a disposal of the Georgia subsidiary and the acquisition of Webtec has been completed during this year. There are specific issued related to Webtec. SAP has been implemented at Webtec (Scapa Group PLC, 2013c). It is a matter of risk. Since implementation of new ERP involves the migration of data. There is a high risk that the opening balances are not transferred correctly. Such data migration requires huge amount of care. The values of Webtec that are consolidated have to be checked thoroughly with respect to Opening balances. Moreover, there is a risk that the setup of the new account balances in SAP is not done appropriately as compared to the previous system. A single typographical error of depreciation rate from 5% to 6% can make a significant error in depreciation calculation. Moreover, the integration of SAP at subsidiary with the system at Scapa Group PLC is also a matter of concern. Reckless integration can lead to Scapa Group PLC results being disturbed. Risk related to Classification under IFRS 5 and IAS 17 There is a risk related to the classification in the financial statements. The company is having both the types of leases. There is a risk that Scapa Group PLC is mis-classifying its assets from the finance lease to operating lease. This will help it to achieve higher costs of lease rentals in the Income Statement, and therefore, tax will be saved. Moreover, this year, there have been specific issues related to IFRS 5. The company has classified its subsidiary’s assets and liabilities as being held for sale. There is a risk that the items are classified before the conditions of IFRS 5 are met. There is also risk attached with respect to the valuation and completeness of the items that are being re-classified. It should be assured that all the assets and liabilities relating to the subsidiary are re-classified at accurate amounts (Deloitte, 2014b). Subjective Nature of Estimates In case of Scapa Group PLC, there are many material provisions involved, which can influence the decisions of the users of the financial statements. The estimate relates to the deferred consideration of the Webtec, which amounts to £ 4.6 mn. Past trend shows that the actual amount installment to be paid increased due to incorrect estimates. Such estimates are more risky than other estimates because this deal is being done with the related party. Collusion between the parties is not an easy task to be detected. Apart from this, there are estimates with regard to the taxes. There are numerous issues of income taxes and deferred taxes in the books of Scapa Group PLC. Given the fact that effective tax rate of Scapa Group PLC has increased, Scapa Group PLC might be induced to save its taxes by manipulating the estimates and calculations of the taxes. The provisions are unchanged since last year. The litigations are in process and it is possible that some of the litigations are reaching their final stages. At final stage, picture becomes clearer and it is possible to estimate the liability with more certainty. There is a risk that the company is not revising the provisions because they might decrease net assets and consequently the gain on sales Disposal of Georgia Subsidiary There are many risk associated with this disposal transaction. Scapa Group PLC shows profit of £ 0.1 mn on disposal transaction. Georgia had already ceased its operations in 1999 (Reuters, 2013). Since then, it has been incurring the costs for defending the litigations. It raises risks because no acquirer would buy a company for a loss, especially an entity like Georgia. The risks are involved with the valuation of the assets and provisions. There has been no change in the valuation of the provisions and insurance of the company. This fair value calculation should be checked in detail. The assumptions taken and the methodologies applied should be tested. This disposal involves the application of two major reporting standards namely, IAS 12 and IFRS 5. It has to be checked whether the conditions of all the standards have been complied with or not. There is a risk related to the classification of the items in the balance sheet. It should be ascertained that all the management expenses of Georgia incurred up to the date of disposal are incorporated in the Scapa Group PLC financial statements. Procedures for Verification of Disposal Transactions Procedures for Controls of Accounting System Such procedures include the following: Re-performing the calculations that are performed by the systems, for example computing the debits and credits to reach the ledger balance. Inquiring the personnel who are responsible for the support of the system about the frequency of the support and maintenance done on the system. Reviewing the correspondence between the accounting staff and the IT personnel about the system performance. Testing the impacts of the transactions on different dimensions including the operational and costing impacts. Substantive Analytical Procedures Substantive analytical procedures to be performed for disposal includes: Comparing the litigation costs with the litigation costs of other cases. If the costs of other litigations have increased then the costs of these asbestos litigations should also increase. And if the costs of other litigation claim have decreased then the costs of asbestos litigation should also decrease. Comparing the insurance receivable amount from the insurance claim of other cases. Sometimes, insurance company reduces the claim amount basing upon the age of the claim. If other claims of Scapa Group PLC reduced due to this condition, then the application of such condition should be tested upon the Georgia subsidiary also (Nick, et al., 2009). The ratio of the provisions to insurance receivable should be computed for different litigations. Then such ratios should be compared with the ratio of asbestos litigations. Here in this case, this ratio is exactly 1:1. It seems ideal as it is hardly possible that the insurance company covers all the risk. Detailed Audit Procedures Detailed audit Procedures on each item are discussed below: Cash and Bank Balance Bank confirmations should be sent. It is observed that the company halted its operations and it was just facing the litigations. There is no change in cash and bank balances; it must be investigated as if there is being any interest generated from the bank accounts. It is possible that such management expenditures are being paid by the interest earned and it is then offset against each other. The confirmation should specifically ask about the interest-bearing bank accounts (Karla & Audrey, 2013). In case, there is any foreign currency maintained, it should be accounted for as per IAS 21. The translation should be done as at the date of disposal (Deloitte, 2014). Insurance Claims Normally, whenever such disposals take place, there exists a risk of the transfer of the title to the policy. Insurance companies not agree to transfer the title to the next acquirer. However, in case of this disposal, the acquiree is itself a subsidiary of Insurance and Re-insurance company (Reuters, 2013). It is highly probable that acquirer has either set the terms with the insurance company or has either agreed to absorb the uncovered portion of the loss itself. A confirmation in this respect should be sent to the acquirer and the insurance company so that the terms of engagement come up with transparency (Basu, 2006). It is also advisable to review the policy of the insurance. Provisions The valuation of the provision with respect to the claims should be considered in depth. The assumption should be corroborated with the industry knowledge. The rationale behind the discount rates used should be considered. Discount rates to be used may be checked by benchmarking to market-sensitive rates such as inter-bank exchange rates. Litigation costs Litigation costs can be verified from the invoices received from the lawyers in past, if they are outsiders. It is possible that Georgia was managing litigations in house, in such a case, the provision would be based upon their remuneration which could be verified from the payroll. Proceeds The proceeds can be verified from the agreement of the disposal between the Scapa Group PLC and the acquirer. If the proceeds have been received then the agreement could be corroborated with the receipts in the bank statement. If partial proceeds are outstanding then their discounting should be reviewed. Discount rates should be compared with the rates prevailing in the markets. In case the proceeds are contingent upon any condition, then the forecasts for such consideration will be checked. It can be checked by way of inquiries with the management. Re-performing the calculations in the forecasts can perform further working. Conclusion Since, disposal does not involve any inclusion of the profit and loss items of the subsidiary in the consolidated financial statements, it makes it less time consuming for auditing. The procedures identified this report are based on the external evidence that can enhance the audit assurance. List of References Basu, 2006. Auditing: Principles and Techniques. 1st ed. Delhi: Pearson Education India. Deloitte, 2014b. IFRS 5. [Online] Available at: [Accessed 27 March 2014]. Deloitte, 2014. IAS 21- The Effects of change in Foreign Exchange Rates. [Online] Available at: < http://www.iasplus.com/en/standards/ias/ias21> [Accessed 27 March 2014]. EU Business, 2014. Poor hit hardest by cuts in crisis-hit Europe. [Online] Available at: [Accessed 27 March 2014]. Karla, J. & Audrey, G., 2013. A Risk based Approach to Conducting a Quality Audit. Mason: Cengage Learning. Nick, D., Anique, Q., Marc, L. & Joel, S., 2009. The complete Guide to Auditing Standards and other Professional Standards for Accountants. 1st ed. New Jersey: John Wiley and Sons. Scapa Group PLC, 2013b. Chairmans Statement - Annual report. [Online] Available at: [Accessed 27 March 2014]. Scapa Group PLC, 2013c. Chief Executive Directors Report - Annual report. [Online] Available at: [Accessed 27 March 2014]. Scapa Group PLC, 2013. Notes to the accounts - Annual report. [Online] Available at: [Accessed 27 March 2014]. Reuters, 2013. Scapa Group plc Disposes Scapa Holdings Georgia, Inc. [Online] Available at: [Accessed 27 March 2014]. Appendix Statement of Financial Position 2013 2012 Variation Assets in % Non-current assets Goodwill 26.4 25.1 5.2% Intangible assets 5.3 6.6 -19.7% Property, plant and equipment 38.4 40.4 -5.0% Deferred tax asset 25.6 28.3 -9.5% Other receivables 0.3 19.6 -98.5% 96 120 -20.0% Current assets Assets classified as held for sale 28.4 0.6 4633.3% Inventory 23.6 20.8 13.5% Trade and other receivables 40.5 36.9 9.8% Current tax asset 0 0.1 -100.0% Cash and cash equivalents 12.6 16.9 -25.4% 105.1 75.3 39.6% Liabilities Current liabilities Financial liabilities: − Borrowings and other financial liabilities -0.3 -0.4 -25.0% − Derivative financial instruments -0.3 0 100.0% Trade and other payables -41.3 -34 21.5% Deferred consideration -4.6 -6.3 -27.0% Liabilities directly associated with assets classified as held for sale -25.7 0 100.0% Current tax liabilities -0.9 -1.3 -30.8% Provisions -0.6 -2 -70.0% -73.7 -44 67.5% Net current assets 31.4 31.3 0.3% Non-current liabilities Financial liabilities: − Borrowings and other financial liabilities -10.1 -9.5 6.3% Trade and other payables -0.3 -0.7 -57.1% Deferred consideration 0 -2.9 -100.0% Deferred tax liabilities -5.2 -4.8 8.3% Non-current tax liabilities -1.5 -1.5 0.0% Retirement benefit obligations -46.2 -38.9 18.8% Provisions -2.3 -26.9 -91.4% -65.6 -85.2 -23.0% Net assets 61.8 66.1 -6.5% Income Statement 2013 2012 Variation 000 000 in % Revenue 208.8 195.6 7% Operating profit 13.3 11.7 14% Trading profit 13.7 10.7 28% Amortization of intangible assets -1.5 -0.4 275% Exceptional items 1.1 1.4 -21% Operating profit 13.3 11.7 14% Interest payable -0.5 -0.3 67% -0.5 -0.3 67% Net discount of provisions -0.2 -0.2 0% Other finance charges -0.2 0 IAS 19 finance cost -0.1 -0.7 -86% Net finance costs -1 -1.2 -17% Profit on ordinary activities before tax 12.3 10.5 17% Taxation on operating activities -4.5 -3.4 32% Taxation on exceptional items -3.6 0 -100% Impact of tax rate on deferred tax -0.3 -0.6 -50% Taxation charge -8.4 -4 110% Profit for the period 3.9 6.5 -40% Read More