Auditing in Scapa Group Plc - Case Study Example

Auditing Case Study – Scapa Group PLC Scapa Group PLC Introduction Scapa Group PLC deals in different products that are sold in different continents of the world including Asia, South America, North America and Africa. The company has shown consistent growth in the revenue over the last 5 years (Scapa Group PLC, 2014) . The company is in phase of acquiring the Webtec (Scapa Group, 2013a). However, the company is facing some litigation in relation to the asbestos. The Group decided to sell its Georgia subsidiary. Decrease in sales was observed in Europe. Exposure of Scapa Group PLC to hedging accompanied with the aforesaid issues makes it a risky company. Risks are discussed in detail in the proceeding sections of this report. Intangibles and Amortization Scapa Group PLC has not made increase in the intangibles during current year. As per policy, the intangibles should be charged on straight line basis which means that the amortization should be similar in all the years. This year, the amortization has increased by 275 %. The company charges the amortization on the basis of useful economic life. As per IAS 38, the economic life and useful life are two different concepts. Amortization has to be charged on the basis of the useful life (Deloitte, 2014). The application of the stated policy is a risky matter. Amortization will increase in case it is charged on useful life and it will decrease in case it is charged on the basis of economic life. The estimate of the life of the matter for technology items is a subjective matter. The reasonableness of such estimates has to be checked. Moreover, it is possible that the research expenditures are qualifying for recognition as a development asset but the company is not capitalizing in order to decrease its profits and save its taxes. Trade and Other Payables Trade and other payables of Scapa Group PLC have increased by 21.5% this year. The trade settlement period this year have increased by 10 days as compared to 2012. This shows that the company is having slight liquidity issues. In future Scapa Group PLC has to settle 15.4 Mn Euros. It is already mentioned that sales of Scapa Group PLC in Europe have declined. Such a decline will decrease the cash to be generated in Euros that would have been used to settle the liabilities in Euro. This exposes Scapa Group PLC to sustain Loss on currency exchange. The valuation of the payables transactions should be checked at year end and during the year also. Apart from this, there is risk related to the existence of the trade and other payables. Such balance may contain fake balances. Scapa Group PLC may record its revenue as a liability. This technique will also let Scapa Group PLC save its taxes as its profits will also reduce accordingly. It is possible that the revenue relating to this year is recorded as unearned revenue. Then subsequently in the next year, that unearned portion is recorded as revenue. This way Scapa Group PLC will be able to decrease current year income and increase next year’s income. Deferred Consideration The deferred consideration is contingent upon the performance of the Webtec. It happened in February 2013 as well, that an additional payment of US $ 10.0 Mn was paid as compared to the estimated amount (Scapa Group, 2013c). The basis of valuing the deferred consideration is a matter of risk. The forecasts of the performance of the Webtec are used to compute the consideration. The assumptions used to value it should be considered in depth. There is a risk of applying incorrect rate of the discount for the consideration. The basis of such discount rate should be investigated. This deferred consideration is also a risky matter because it is a related party transaction (Scapa Group, 2013d). Related party transactions can be manipulated easily (IFAC, 2009). Webtec may provide incorrect information in order to develop high forecasts with respect to the performance. Such high forecast will let Webtec achieve high proceeds. Consequently, the gain on the sale to Scapa Group PLC will also decrease. Taxation Scapa Group PLC is subject to different taxation laws prevailing in different jurisdictions. This makes the accounting matters related to tax and deferred tax more complicated. Scapa Group PLC’s tax losses available have started to extinguish. The group has made tax payments of £ 2.3 Mn this year. This might incline Scapa Group PLC to reduce the profits. Computation of deferred tax assets and liabilities have to be investigated in more details. The tax expenses available and not available have to be checked in details. Scapa Group PLC deferred tax assets increased to £ 11.2 Mn from £ 9.8 Mn in 2012. These relate to the payments relevant to the pension fund. The actuarial valuation and estimates that have been used have to be considered in detail because these tax assets may have been the expense for the current year. Incorrect re-classification may reduce this year’s expenses. Scapa Group PLC may do this because this year its effective income tax rate has increased from 38.1 % in 2012 to 68.3 % in current year. Disposal of Georgia Subsidiary The Georgia disposal is of high risks due to the fact that most of its net assets are estimated. It consists mainly of the insurance and litigation provisions. Both these items are subject to estimation. The assumptions of such estimates should be considered. They are taken at their book values without any change. It has to be checked whether all the conditions that were the basis of book values still exist at the date of disposal or not. As happened in case of acquisition of Webtec, it is also possible that the consideration is contingent and the forecasts for such contingency are changed. Such a change will change the gain on the disposal transaction also. It should also be checked whether the new acquirer bears all the risks associated with the litigations or not, and that the insurance company is ready to transfer the policy in the name of acquirer. Procedures for subsidiary Disposal For each component of the internal control, tests are mentioned opposite to it (Steven, 2000): Component of Internal Control Tests to be performed 1 Control Environment This could be tested by the emails sent by the management to those who are actively involved in the execution of the disposal transaction. Reviewing the minutes of the meeting. More importance to be paid to those points which focuses on the questioning related to the transaction. Reviewing the profile of the individuals involved in the transaction so that there competence and experience can be judged. 2 Risk Assessment Reviewing the minutes and correspondence between the management and officials and looking for the points related to the risks associated with the transaction and the actions to be taken to reduce such risks. Significant risks associated with the transactions are as follows: Risk of the disposal being taken at loss Risk that litigations are not being transferred completely to the acquirer Risks that the insurance company does not agree to pay the full amount of insurance to the acquirer in case the verdicts comes against it. This is because insurance companies might fear that the acquirer will not hire the legal counsel of such a caliber as that which was hired by Scapa Group PLC. Risks that the valuation of the subsidiary is not being done at the correct amount and Scapa Group PLC is unable to receive the actual proceeds that should be charged 3 Control Activities Maintaining proper segregation of duties to ensure that one person or group is not able to dominate the disposal for his own advantage. Duties should be segregated amongst the negotiations, legal and valuation functions at least. The events that are taking place during this whole transaction must be checked and approved with seniors. Due to magnitude of the transaction, the transactions should be approved by the director(s). 4 Information and Communication This segment could be verified from reviewing the reports that are being sent by the team to the management. Any questions that were raised by the management and the revision that was made to the report. This could be verified by reviewing the report drafts and minutes of the meetings Frequency of follow ups by the management with regard to the disposal transaction. This could be verified from the emails that are being sent to the team on behalf of the management Frequency of the reports and meeting with regard to the disposal 5 Monitoring of The Controls Since this disposal transaction was a non-routine transaction and it kept engaging the management and the other officials of the Scapa Group PLC throughout the process. If above components were working well then the monitoring was doe throughout the transaction by the management. Substantive Analytical Procedures Following substantive analytical procedures need to be performed with respect to the disposal of subsidiary: Comparison with the prior year data All the significant items of the Georgia subsidiary have to be compared with the prior year data. Such items may include the litigation claims, the insurance claims and other provisions. The comparison drawn will guide the further inquiries to be made to management. The cash and balance should not be significantly high with respect to the prior year comparatives. This is because the subsidiary was in process of being disposed off. In such scenarios normally operations are disturbed or halted. This disturbance in the operations should disturb the cash flows (Nick, et al., 2009). Detailed Audit Procedures Cash and Bank Balances Following procedures will be performed as per the assertions addressed: Assertions Procedures Completeness, Rights and Obligations For ascertaining the completeness of bank balances, the list of the bank balances available with the subsidiary should be obtained. The list then obtained should be compared with the previous year bank balances. Proper authorization should be verified in case of addition or deletion of the bank account from the bank balances. The amount of the bank balances can be verified from the bank confirmations (Virender & Ravinder, 2011). Bank statements show the title of the account holder. That will provide the evidence that the bank statement in is the name of Scapa Group PLC or in the name of Georgia subsidiary. Accuracy In case there are any bank balances available in foreign currency, there re-valuation should be done as at the date of disposal. Classification Once the bank statements are verified, care should be taken that all the banks that are of subsidiary should be classified as held for sale and none of the bank balance should remain in the consolidated books of Scapa Group PLC. Insurance Assertions Procedures Completeness, Rights and Obligations The verification of the insurance can be done by examining the policies of the insurance. Those policies will validate the title of the policy holder (Basu, 2006). Accuracy This is possible that the insurance policy amount may change. This happens mainly in the case when the insurance policies are revised during the year. The change in the insurance amount can be verified from the insurance policies also. It is possible that the insurance company is not willing to endorse the policies in the name of the acquirer. This should be confirmed from the confirmation with the insurance company. Litigation Claims The value of the litigation claims can be verified from the confirmation of the legal advisor. The discounting of such value is a critical matter. The rate used should be inquired from the management. Moreover, the assumptions used for such discounting should be reconciled with the market situations. List of References Basu, 2006. Auditing: Principles and Techniques. 1st ed. Delhi: Pearson Education India. Deloitte, 2014. IAS 38. [Online] Available at: http://www.iasplus.com/en/standards/ias/ias38 [Accessed 25 March 2014]. IFAC, 2009. ISA 550 Related Parties. [Online] Available at: http://www.ifac.org/sites/default/files/downloads/a029-2010-iaasb-handbook-isa-550.pdf [Accessed 25 March 2014]. 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, 2014. Financial Summary. [Online] Available at: http://www.scapa.com/en/FinancialSummary [Accessed 25 March 2014]. Scapa Group, 2013a. Financial Directors Review - Annual report. [Online] Available at: http://www.scapa.com/files/Scapa_RA-2013.pdf [Accessed 25 March 2014]. Scapa Group, 2013c. Finance Directors Review - Annual Report. [Online] Available at: http://www.scapa.com/files/Scapa_RA-2013.pdf [Accessed 25 Mach 2014]. Scapa Group, 2013d. Related Party Transactions - Annual report. [Online] Available at: http://www.scapa.com/files/Scapa_RA-2013.pdf [Accessed 25 March 2014]. Steven, R., 2000. Beyond COSO - Internal Control to Enhance Corporate Governance. 1st ed. New York: John Wiley and Sons. Virender, S. & Ravinder, K., 2011. Auditing- Principles and Procedures. 2nd ed. Delhi: PHI Learning Pvt Ltd. Annexures: 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