1. ‘Key’ Inherent Risk Factors that could have an Impact on the Audit of Elders Limited for the Year ended 30th September 2013 and/or Future Audits
(I) Employee Cutback
In July 2012, Elders Limited dismissed about seventy-five corporate and back office jobs in its bid to build viable, long-term business (Austin, 2012). The company alleged that this move would cost $3.5 million and save between $8 million and $9 million per year (Austin, 2012). Also, ninety-eight FTEs had to leave the company as part of the business reorganisation announced to the ASX on 10 September, 2013 (Elders Limited, 2013, p. 3). As per ASA 315/ISA 31, an auditor should identify and assess the risk of material misstatements. Identification and assessment of the risk of material misstatement should take place at the financial level and the assertion level (Gay & Simnett, 2010).
As an auditor, it is necessary to identify whether the risk is related to fraud, transactions complexity and subjectivity in the measurement of financial information (Gay & Simnett, 2010). Employee cutback by Elders Limited may create an inherent risk because it is results into calculations of employee entitlements and provisions for employee redundancy, which are associated with retrenchment. Creation of provisions for employee redundancy and calculation of employee entitlements is a complex task. Consequently, there is a possibility of making calculation errors in items like entitled termination payments and others.
(II) Discrepancies in the Company’s Export Business
During the month of September, 2012, Elders Limited recognised potential discrepancies in the company’s export business (Binsted & Sprague, 2013). The executive team responsible for global live cattle trading left the Group to join Ruralco, a major competitor that had even attempted to take over Elders Limited. There were some discrepancies, which were identified in the reporting and recognition of livestock values of the Group’s live cattle export division. The company believed that the issue would not have a material financial impact. The issue was then subjected to full investigation to establish whether the discrepancies discovered are material (Binsted & Sprague, 2013).
Discrepancies in the Company’s live cattle export trade poses an inherent risk that could lead to material misstatement in the financial statements of Elders Limited. It was established by the board of the group that the carrying value of livestock inventory had a discrepancy, though internal audit and full investigation was underway by then. Discovery of the discrepancies is a clear indication that the accounting treatment was not adequate (Binsted & Sprague, 2013). Given the nature of the business environment in which Elders Limited operates, such discrepancies create a high chance of misstatement or misreporting because the figures of livestock values may be inflated or understated, leading to a situation where the reported Group income is forged. These areas can lead to a wrong conclusion by the auditor, if special audit procedures are not adopted.
The reported discrepancies may have resulted from the nature of valuation of livestock, which involves a high degree of estimation. Inaccurate recording of transactions and presentation of financial information is associated with inherent risk (Johnstone, Gramling, & Rittenberg, 2014, p. 277). For instance, the Group had to include a charge of $24.3 million to adjust cattle inventory to fair value and restate other trading related balance sheet items. The group took this step after it identified that certain cattle sales outcomes had not been recorded in line with accounting policies for the global cattle trading operations. By the time the Group’s financial report was compiled, the external forensic accounting consultant, PPB Advisory, which was to examine the company’s global cattle trading operations, had not provided its final report (Elders Limited, 2013, p. 10). Given that the investigation report had not been provided, inherent risk is feasible, and this may lead to incorrect figures of profit reported. Consequently, the auditor can make a wrong conclusion, if special audit procedures are not adopted.
(III) Pending Legal Claims
There are several legal claims that had been lodged for damages, resulting from the use of products or services of the Group (Elders Limited, 2013, p. 91). Management of the Group had not made any provisions because it thought that it was not probable then that the claims would succeed. Management also believed that it was not practical to estimate the potential effects of the claims. The Group’s management thought that the claims may not have been material and were not expected to have a major impact on the group’s financial presentation.
The assumption that the pending legal claims, filed against the Group, may not be material is expected to create an inherent risk. It is impossible to determine the outcome of the legal claims. As such, some legal claims may become a major impact on the Group’s financial presentation, in case they materialise. It is possible for the Group to understate the legal actions, which may be taken to settle the claims filed against Elders Limited. As a result, wrong values for the Group’s net income and financial position may be misstated. The auditor is required to investigate the financial cost associated with these claims and avoid relying on management assertions because this may mislead an auditor to make a wrong opinion.
(IV) Threatened Going Concern
For the past few years, including the period under investigation, the Group’s losses have been increasing, especially in 2013. In addition to this, the suspension of cattle exports to Indonesia threatened financial performance of the group. The business also risked being taken over by companies like Ruralco.
The ability of the Group to operate as a going concern in the foreseeable future seemed to be under threat during the period under audit. Inherent risk increases because, with a threatened going concern, the Group is most likely to inflate its income in the financial statements to report a better financial position. Major losses for the group could lower the Group’s chances of obtaining additional capital to continue with its operations. Therefore, it is probable that management may inflate income items in the financial items to better the Group’s financial position, leading to possible misstatements.
During the period under audit, there was a major shortcoming because of the suspension of cattle exports to Indonesia. Consequently, the Group’s going concern was in further threat because the anticipated income could not be realised. In addition, the group risked insolvency as it lacked sufficient capital to continue with its operations. Elders Limited became vulnerable to insolvency or acquisition by other companies. For instance, Ruralco communicated its interest to acquire the Group, but the Group was lucky because it sought finance from banks successfully. Such events increase the inherent risk because management may resort to misstate the financial position of the Group to please financiers and obtain credit. The auditor is required to investigate every income item in the financial statement to avoid making a wrong conclusion.
(V) Integrity of Management
The integrity of the group’s management is highly questionable, especially the export trade department executive staff. The group’s global live cattle trade executive staff may have taken part in distorting the livestock values. There might have been factors that predisposed management to misstate the financial statements or information, probably because the company was facing business failure and lack of sufficient capital to continue with its operations.
Information has indicated that the Group’s senior management such as the executive staff of the global live cattle trade somewhat lacks integrity. A possible implication is that such staff members can provide wrong figures, which have been tailored to be used in the compilation of the Group’s financial statements. For instance, there was a discrepancy in the livestock values recorded from the global live cattle trading department (Binsted & Sprague, 2013). Possibly, these wrong figures were used to calculate the Group’s financial position. In addition, the investigation results had not been provided by the time the Group’s financial report was compiled. Therefore, it had not been established whether these discrepancies were material. An auditor can make a wrong conclusion, if the group’s reported financial information is to be relied on, without carrying out special audit procedures.
Separately, the Group’s key personnel, the executive of the global live cattle trading division, left the enterprise during the period under audit. The executive team left Elders Limited while investigations were still ongoing. They joined Elders Limited’s major rival, Ruralco (Binsted & Sprague, 2013). There is an implication that there could be material errors in the calculation of the Group’s income and reporting of its financial position, in case it turned out that the discrepancies were material. Consequently, inherent risk is high because it is highly probable that livestock values were misstated, leading to errors in subsequent calculations such as trade receivables and income. The Group’s industry is unfavourable. Elders Limited is facing business failures while it lacked sufficient finance or capital to continue with its operations. Therefore, management was likely to be motivated to misstate financial statements because the Group’s financial performance and position were not satisfactory.
(VI) Incomplete Divestments, Discontinuation and Impairments and Restructuring
During the period under investigation, there were various uncertainties arising from discontinuity, divestments, restructuring and impairments (Elders Limited, 2013, p. 9). These uncertainties may have led to material differences between the actual, future gains and losses from the estimates. Costs pertaining to divestments, restructuring, discontinuation and impairment may not be included in the financial statements because they are related to activities that are deemed to benefit the Group’s future periods. In addition, these costs or gains are based on assumptions and estimates.
An increase in the number of items on a company’s financial statements, which are subjective and based on judgement such as impairments and estimates on the useful lives of assets, may lead to occurrence of errors in the calculation of the Group’s statutory income. The Group is required to calculate amounts based on estimates for uncertain matters such as restructuring liabilities. In addition, inherent risk may result from management’s competence and integrity, in case there are incentives, which will make them to misstate the financial statements and inflate earnings, given that the Group’s current financial performance is poor.
2. (a) Brief Discussion on how Each Inherent Risk will impact on the Evidence Mix for the Planning of the Audit of Elders Limited in the Relevant Segment of the Audit using the Audit Risk Model
(I) Employee Cutback
The audit risk model provides that audit risk is equivalent to the product of inherent risk, detection risk and control risk (Rittenberg, Johnstone, & Gramling, 2012, p. 140). Therefore, there are possibilities that misstatements may not be recorded while the control systems may fail to recognise and prevent misstatements in time. In addition, there are possibilities that audit procedures may fail to detect misstatements. The Group’s decision to lay off seventy five back office employees and ninety eight FTEs as a restructuring effort implies material misstatement in various areas (Austin, 2012; Elders Limited, 2013, p. 3).
The items that are likely to be misstated include amounts paid to suppliers and employees, presentation of employee benefits and provisions made by management to settle relevant obligations. In this case, failure to disclose the exact number of employees dismissed may call relevant assessment of inherent risk because contingent liabilities may exist for supplier and employee payments, employee benefits and provisions. The auditor should check whether the correct values of amounts reimbursed have been indicated in the statement of comprehensive income. Management has been urged to ensure that it makes the best estimates of the provisions for the expenditures required to settle such obligations.
(II) Pending Legal Claims
As for the pending legal claims, the move made by the management of Elders Limited to ignore creating any provisions for them may result into material misstatement in various areas. Management took this step because it was presumed that it was not probable that the claims would succeed. In addition, management presumed that it was not practical to estimate the potential effects of the claims.
The items that are likely to be misstated include quantified contingent liabilities and those that cannot be quantified (Elders Limited, 2013, p. 91). If the Group does not disclose the number of pending legal claims and the anticipated amounts that the Group will pay to settle the issues, relevant assessment of inherent risk is required because contingent liabilities may exist for money paid to settle legal claims or disputes. Therefore, management will have to ensure that it creates provisions for the anticipated expenditures required to settle such legal claims.
(III) Threatened Going Concern
Elders Limited was under threat of losing its capability of operating as a going concern. Given the major losses that were realised in May, 2013 and the suspension of cattle exports to Indonesia, the Group’s financial performance was threatened. In addition, lack of sufficient capital for the Group to continue with its operations increased the risk of insolvency and possible acquisition by other companies (Binsted & Sprague, 2013). Material misstatements are expected in several areas. For instance, the amount of sales may be inflated while expenses may be understated to report better financial performance, given that the Group sought debt financing. Also, information about the Group’s capital management may be misstated. Failure by the Group to provide full disclosure of its going concern status requires investigation of inherent risk. The net debt held by the Group may be misstated. It is advisable that the Group’s management makes full disclosure about its status of going concern.
(IV) Integrity of Management
Probable material misstatements may be reflected in valuation of assets and inventory, in case the integrity of Elders Limited is questionable. Another area that has a potential of misstatement is the underlying earnings reported. As for the Group’s inventory, there were discrepancies that were discovered by the Group’s management in 2012 (Binsted & Sprague, 2013). Such discrepancies indicate the inherent risk that may result when senior personnel of a company are dishonest. Failure by the Group to provide the full investigation report and disclosure about the discrepancies compels an auditor to investigate inherent risk. These discrepancies are likely to lead to material misstatements of other items pertaining to the Group’s financial position, which could not be detected or prevented. Management is required to provide a full report whether the discrepancies were material, upon completion of investigations by the external consultancy company.
(V) Incomplete Divestments, Discontinuation, Impairments and Restructuring
It is probable that lack of full disclosure of information pertaining to incomplete restructuring, impairments, divestments and discontinuation will lead to material misstatements. Areas such as restructuring redundancy and other write downs, loss and gain on sale of assets, impairment of intangibles such as goodwill, brands and others will be affected (Elders Limited, 2013, p. 9). Also, the impact of tax on items not included in the profit and restructuring provisions are subject to material misstatements. Inherent risk is most likely, and this calls for investigations on Elders Limited. In case Elders Limited does not provide full disclosure on values related to incomplete restructuring, impairments, divestments and discontinuation, there will be material misstatements in other items pertaining to the Group’s financial position, which may not be detected or prevented. Management should provide full disclosure about provisions, gain, loss, impairments, tax and provisions on restructuring to minimise the risk.
(b) Assessment of Going Concern of Elders Limited
In light of ISA 570, assessment of an entity’s going concern helps an auditor to examine whether the entity has the ability to continue its operations for the future (Rittenberg, Johnstone, & Gramling, 2012, p. 828). As for Elders Limited, the Group has problems with its going concern because negative trends have been recorded by the Group. Such trends include the Group’s deteriorating financial position, characterised by recurring losses. Deficiencies in working capital, which the group experienced during the period under audit, almost led to insolvency of the Group (Binsted & Sprague, 2013). The Group’s operation activities yielded negative cash flows during the period under investigation. As reported by the financial press, the Group lost some of its key employees to Ruralco, one of the major competitors of the Group. The executive staff of the Group’s global live cattle trade division left the company when investigations on financial discrepancies were still underway. In addition, it has been reported that the Group could not issue dividends because its finance facilities could not allow (Elders Limited, 2013, p. 32). There was a large debt that had to be repaid by the Group before payment of dividends could resume.
The industry in which Elders Limited operates has turned out to be unfavourable for improvement of the Group’s financial performance. Significant changes in the competitive market have been recorded while issues like the suspension of cattle exports to certain locations have been witnessed. Also, adverse weather conditions contribute towards the destruction of the Group’s products and reduction of profits.
There are problems with the going concern of Elders Limited, based on the aforementioned inherent risks. The problems have been identified through the analysis of events, which provide insights about the Group’s financial performance. Therefore, it has been concluded that there are problems with the going concern of the Group. However, Elders Limited has taken relevant actions to ensure that it works out its challenges. For instance, the Group is undergoing restructuring, which incorporates retrenchment of employees to reduce expenditure by cutting off unnecessary spending. In addition, the Group liaised with various banks to obtain finance to aid it in carrying out its business operations. The Group’s restructuring approaches include the sale of its core assets, as it seeks to become an agricultural pure play company (Elders Limited, 2013, p. 10). The Group has sold out its rural services while it engages in divesting some assets that are not relevant to its new strategy. Therefore, there is restructuring of assets and operations, which is meant to improve the Group’s financial performance in the future (Elders Limited, 2013, p.6). The Group’s effort to reduce debt is an ideal step that has been taken to address problems with its going concern.
References
Austin, N., 2012, July 30. Elders axes 75 Jobs to Focus on Leaner Future. [Online] Available at:<http://www.adelaidenow.com.au/business/sa-business-journal/elders-to-cut-75-jobs-in-adelaide-headquarters-back-office/story-e6fredel-1226438572906>[Accessed 8 October 2014].
Binsted, T., & Sprague, J.-A., 2013, October 2013. Elders Staff join Ruralco amid Trading Investigation. [Online] Available at:<http://www.afr.com/p/markets/market_wrap/elders_staff_join_ruralco_amid_trading_PC52JI5jGqKIWciKlfTyCP>[Accessed 16 April 2015].
Elders Limited., 2013. 2013 Annual Report. [Online] Available at:<http://www.elderslimited.com/investor-centre/annual-reports?Year=2013>[Accessed 8 October 2014].
Gay, G., & Simnett, R., 2010. Auditing and Assurance Services in Australia 4e. North Ryde: McGraw-Hill Australia Pty Ltd.
Johnstone, K. M., Gramling, A. A., & Rittenberg, L. E., 2014. Auditing: A Risk-Based Approach to Conducting a Quality Audit. Mason: South-Western Cengage Learning Press.
Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A., 2012. Auditing: A Business Risk Approach. Melbourne: South-Western Cengage Learning Press.