The Revision: Inherent Risks - Essay Example

Revision: Inherent Risks Work Count: 1733 (excluding Appendix) Review of qualitative information Purpose: Analysis of the information about the selected Company available Publicly to determine Speciality Fashion Garments Ltd (SFH ) inherent risks for the purpose of audit planning and performance. Scope: This study has been executed through subjective dissemination of Information available from public sources and thus needs to be reinforced with empirical research for a more comprehensive study in order to arrive at conclusive results. Drawbacks: This study suffers from the lack of inside information about the Functioning of the chosen Company, and to this extent, its applicability serves limited applicability Sources: Web related sources and Company Annual Report. Corporate Restructuring: the Company has restructured its business since 22 December 2005 by selling off its Discount Variety Segment as reported in its Financial Report for 2007. (Speciality Fashion Group Annual Report. 2007. P. 46). There is an inherent risk that the accounting treatment of this restructing may possibility entail misstatements, considering that it is a non- routine transaction. Consolidation of shares: The shareholders approved an 8:10 ratio for consolidation of holdings effectively reducing the number of shares from 245 M to 196 M. The impact of this on the total shareholdings needs to be independently addressed by the auditors. Undervaluation of shares: The management believes that the shares of the Company have been undervalued and hence has reduced the holdings on 30.6.2007 by buying back 5.2.Million Shares valued at $9.3m. (Speciality Fashion Group Annual Report. 2007. P. 8). Its impact on the present holdings needs to be reviewed by auditors. Climatic Risks that impinge upon Co.'s business: It is seen that the Company, which specializes in women's garments has had lowered business trends during the winter months, especially the peak Christmas season. Moreover the various seasonal competitions has also slackened business prospects. Risks associated with the rapport and reliability of key employees: The management functions as a closely knit operational team and decisions are made on consensus. Although the members of the team are highly motivated, committed and dependable, there are always risks of management employees' attrition, for better prospects and higher positions. This could be perceived as an inherent risk in this Company Risks associated with need for strategic growth: The women's garment industry in Australia and New Zealand are the main areas of marketing focus by this Company. There is always a dormant risk that customer preferences and tastes may change, due to conspicuous changes in fashion industry needs and competitive environment, in which the Company operates. Although the Company has designed garment wear for all age groups, income stratas and lifestyles, the inherent risks of a high degree of fashion obsolescence cannot be ruled out, which could affect demand for the products and cost of carrying inventories. Supply Chain Management risks and strategic vendor relationships: The Company presently has 784 locations situated in Australia and New Zealand. (Speciality Fashion Group Annual Report. 2007. P. 10). Many more stores are going to be opened to future to cater to the increasing clientele and it is necessary to have the necessary efficient logistics in place so that all the stores are well stocked with stocks at all times. It is therefore a test for the supply chain management systems in operation to build up efficiency and prompt dispatches and also have excellent vendor network so that goods are speedily replenished and restocked at all locations. The inherent risks arise when, due to failure of the system, ordered supplies are not available on demand, which could reflect upon the reordering systems in vogue. Review of quantitative information Purpose: The purpose of this analytical review was to assess Speciality Fashion Garments Ltd Ltd's inherent risk for audit purpose for audit planning by comparing critical areas of corporate performance over a 5 year period to determine the trend of business which is an important factor in the garment industry.. Scope: The aspect of abnormalities and non-routine aspects of the business and its impact on the financial results is being discussed. . Drawbacks: In the case of Speciality Fashion Garments Ltd, it is found that the sale of a non-profit unit has considerably impacted their bottom line as would be explained in the following pages. In a study of this sort it is also important to consider industry comparisons, especially in the ladies garments and wear industry, in order to know the current trends in the industry as a whole, in order to conduct industry comparisons. Sources: publicly derived sources Areas of focus in the case of SFH The main areas in which attention needs to be focused in the case of Speciality would be 1. Profitability 2. Rise in certain types of expenses 3. Abnormal reduction in the value of assets 4. Increase in the value of liabilities could affect future operations Profitability The profitability of the Company for 5 years has been as follows 2003 2004 2005 2005 2007 $ 30,504 $ 8653 $(98,203) $24,624 $(13,810) $25114 In the year 2005, the profits from the continuing operations was affected by the losses sustained on sale of discount business. Therefore the effective loss was $13,810. It is seen that the profits are not consistent over the five year period which may erode the credibility of potential investors. This is also as risk factor since it is possibly that in the near future other stores or segments may also need to be sold out on losses. Net assets positions Again if we are to consider the net assets position for 5 years under review, it is as follows 2003 2004 2005 2006 2007 $ 215,876 $ 208,124 $83,652 $69,316 $ 19,361 The percentage fall in the value of assets over the 5 year period would be : Therefore it could be seen that there is an imminent risk of assets fall around 38% which is a matter of concern for the auditors, since it could be a sign of asset mismanagement. Risks pertaining to liquid assets: Further it is also seen that the cash and cash equivalent have dropped to $ 6752 in 2007 from the value of $71,046 in the corresponding period of 2006, a fall of nearly 90%. Which is clearly a high risk factor for this company, especially for payment of short term debts. Rise in certain heads of expenditures: Next coming to the expenses, it is seen that the following head of expenses have risen abnormally as stated below: It is seen that there is an abnormal increase of around 14%. It needs to be assessed whether the key management personnel have any interests in the leasing of premises, and if so, the same needs to be disclosed to the shareholders. Assets: liabilities risks It is also seen from a perusal of the audited financial accounts that although the asset values have reduced from$166,129 to 118,603 between the years 2006-07, representing a fall of 29 %, the amount of Net liabilities have increased from 96,813 to 99,242, that is an increase of nearly 2.51 % .It is a matter of inherent risk that in the case of this company there is a case of erosion of assets and mounting of liabilities. Memorandum To: Chief Audit Manager, From: Michelle Smith, Internal Auditor Date: 16 January 2007 Subject: Results of assessment study of inherent risks in M/s.Speciality Fashion Garments Ltd. Sale of losing Segment: During the course of the audit conducted it was found that several inherent risks, some of them of critical significance, had been established in this company. In the first place, the Company had sold one of its losing units at a loss of $ 38,434, which has impacted its Balance sheet in 2006. It needs to assessed that being a non-routine transactions, the aspects of correct accounting treatment and loss assessment has been registered. It also needs to be verified that it was carried out with the approval of majority directors and shareholder so the Company, since it is a transaction which affects these parties. Share consolidation and reduction of share capital: Next it is seen that there has been both a consolidation of shares and also, on the belief that the shares are undervalued, the Company has purchased back 5.2 Million shares for $ 9.3. This buyback transaction needs the approval of the concerned authorities including compliance with the listing rules prescribed by the ASE and the Corporation Laws 2001 which governs the functioning of this company. Erosion of asset values over time: Coming to the financial aspects, it is seen that the company has inherent risks of erosion of assets overt a five year period in which nearly 38% reduction in the value of assets are taking place as detailed in the study. The cash balance during the current year 2006 -07 has fallen by nearly 90% to close at $ 6752. There has been substantial fall in the value of total assets of the Company, thereby making it at high risk for lowered performance in the years to come, unless remedial steps are taken to correct the asset decline through strong investment and debt management policies. Market risks specific to Speciality Fashion Garments Ltd: Coming to the inherent non financial risks, it is seen that the type of industry to which this Company belongs could be subjected to reduced turnovers and high carrying costs of inventory due to market forces and consumer preferences. Although it is an established brand, it caters to a select clientele, and therefore, it may not be in a position to effect market repositioning speedily and effectively. Conclusion: To conclude, it may be said that there a lot of factors that could be termed as inherent risks to this Company and it is heartening to know that the Company has launched a Risk Management Program that would not only identify and measure the impact of risks but would take up definite and concrete steps for their alleviation and possible elimination in the time to come. (End of text) Appendix 1 Risk Area: Performance of outlets Comments Risk (Y/N) Action Summary of review of qualitative information Controls enforced high Likelihood of materiality of the misstatement Possible high Summary of analytical review on quantitative information Risk management system in force high Risk Area: Rapid Growth in marketing Comments Risk (Y/N) Action Summary of review of qualitative information Controls enforced high Likelihood of materiality of the misstatement medium Summary of analytical review on quantitative information Risk management system in force high Risk Area: Financing management Comments Risk (Y/N) Action Summary of review of qualitative information Use of risk management medium Likelihood of materiality of the misstatement Very much possible high Summary of analytical review on quantitative information Massive increase of asset value and reduction of liabilities very high Need for specialists intervention Risk Area: Supply chain management strategy and logistics Comments Risk (Y/N) Action Summary of review of qualitative information Development of strategic business units high Likelihood of materiality of the misstatement Possible high Summary of analytical review on quantitative information Needs to be further researched medium Risk Area: Rapport with key officers Comments Risk (Y/N) Action Summary of review of qualitative information Rapport to be enhanced medium Likelihood of materiality of the misstatement medium Summary of analytical review on quantitative information Reflects in the final performance analysis medium Risk Area: Control over assets Comments Risk (Y/N) Action Summary of review of qualitative information Needs to be reviewed regularly high Likelihood of materiality of the misstatement Internal control mechanism high Summary of analytical review on quantitative information Use of risk management system high Works cited Speciality Fashion Group Annual Report. Discontinued operations. Financial statements for the year ended 30 June 2007. P. 46. 2007. 16 Jan. 2008 . Speciality Fashion Group Annual Report. Brand Portfolio Update. Financial Report. P. 10. 2007. 16 Jan. 2008 . Speciality Fashion Group Annual Report. Balance Sheet, Cash Flow and Capital Management. P. 8. 2007. 16 Jan. 2008 . Read More