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SNC Lavalin Final (For Real)
SNC Lavalin Final (For Real)
By: Tan Trung Ly - 5499003 Nadia Nessim - 9758496 Daniel Knobovitch - 9340602 Jean-Pierre Hatim - 1709046
ACCO 450
Table of Contents
Table of Contents .....................................................................................................2 1. Team composition and Time Sheet ..................................................................3 2. Understanding the Entity and its Environment ...............................................4 2.1 Engagement Characteristics .................................................................................4 History Overview ....................................................................................................5 Revenue Sources Breakdown ..................................................................................6 2.2 Business Risks......................................................................................................7 3. Analytical Procedures ........................................................................................10 5. Audit Risk Model ...............................................................................................15 6. Conclusion...........................................................................................................20 References ...............................................................................................................21
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Last Name
Signature
Project
Member(s) Assigned
Prepare/Review
Understanding the Entity Analytical procedures Materiality Audit Risk Model Conclusion
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Management is expected to give a true and fair view of the financial situation of the company. In other words, suitable accounting policies are applied consistently using reasonable and prudent judgments. The financial statements should be prepared on a consolidated and going concern basis. All amounts figuring on these statements are in Canadian currency. Last but not least, all companys records are made available to the external auditor.
Independent auditors attempt to obtain reasonable assurance as to whether the amounts and disclosures figuring on the financial statements are free from material misstatement (i.e. error or fraud) and within ethical guidelines (Smieliauskas and Bewley, 2013). These audit procedures include understanding the organization, its environment and internal control over financial reporting.
Based on the results, an opinion, or the absence of, is expressed as to whether the consolidated financial statements are presented fairly, in all material respects. These reports will then be filed to the Ontario Securities Commission in a timely manner, normally within 90-120 days, in order to assist stakeholders, more precisely SNCs shareholders, in their decisionmaking. This engagement is for the fiscal year ending is on December 31, 2012.
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History Overview SNC-Lavalin Group Inc was founded in 1911 by Arthur Surveyer in Montreal under the name of Surveyer, Nenniger & Chenevert Consulting Engineers (SNC). The entitys first appearance in the international market was in 1963, when it signed a contract to build a train station in India. Having enjoyed steady growth, this small office decided to incorporate in 1975, changing its name to SNC Inc. As the years passed, SNC became so large that, in 1986, the firm decided to go public. However, the most important benchmark in SNCs history is unquestionably the merger with Lavalin Inc., the other largest engineering firm in Canada at that time, evolving it to SNC-Lavalin Inc.
Today, as a global leader, SNC-Lavalin is active in multiple sectors such as agrifood, aluminum, biopharmaceuticals, hydrocarbons & chemical, the environment, facilities and operations management, infrastructure, mass transit, mining and metallurgy and power (SNCLavalin, web).
Recent News and Controversies SNC-Lavalin was under political fire in the last few years. In fact, the firm was accused of fraud, corruption and using false documents (Barnes, web). These allegations implicate SNCLavalin in several countries. Here are some examples: Algeria, where its offices are being raided for a bribery concerning an $825 million contract (Seglins and Nicol, web) Libya, regarding a $160 million bribe Canada , for the construction of the McGill University Health Center (Cousineau and McArthur, web). Furthermore, SNCs top level executives were charged with fraud by Canada and Switzerlands anti-corruption investigators which led to their dismissal (Cousineau and McArthur, web). According to the World Banks list of 250 firms banned from bidding on global project due to fraud and corruption, 117 were from Canada. Among these 117 listed firms, 115
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were SNC-Lavalin and its affiliates (Ligaya, web). In other word, it is without a doubt that there is a sharp decrease in investors confidence, which will impact materiality level and the audit risks assessment. Revenue Sources Breakdown SNC-Lavalin earns profit through multiple sources of revenue, namely from its Services, Packages, Operations and Maintenance (O&M) and Infrastructure Concession Investments (ICI) (2012 MD&A, web). A breakdown of each category and their respective percentage of total revenue are shown in Exhibit 1 below. Exhibit 1- Sources of Revenues Breakdown (in thousands)
Type Services Packages O&M ICI Total $ $ Revenue 3,174,934 3,020,400 1,330,501 565,125 8,090,960 % of Total Revenue 39% 37% 16% 7% 100%
Service activities consist of engineering services, feasibility studies, planning, detailed design, contractor evaluation and selection, project and construction management, and commissioning.
Packages include different service activities mentioned above combined with the responsibility of providing materials and equipment, and generally involve the actual construction activity (2012 MD&A, web).
Together, these two sectors represent 76% of total revenue from operations. As such, due to its multiple sources of revenues and reliance on Services and Packages, SNC is exposed to various business risks.
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In the event that the costs incurred are higher than the tendered price, the discrepancy will reduce profit or be forcefully recognized as a loss, possibly causing solvency issues. The competitive nature in which SNC operates represents one of its greatest risks. As it operates on an international level, the firm must compete with many other large, mid-size and small businesses that provide equal services. In addition, similar competition is entering the Canadian Market place. Since contract prices are determined by the overall state of markets and level of competition, this consequently presents a risk to SNC-Lavalins results of operations (2012 MD&A, web). As the firm is active in more than 100 countries, foreign contracts are thus vital to SNCLavalins business operations. Foreign involvement is complex due to many factors. The company is exposed to political, environmental, and economical risks when contracting outside Canada such as recessions and crises in European countries. Embargoes, terrorist attacks and acts of war are also factors that can adversely affect the daily operations of SNC-Lavalin. Weak foreign economies are therefore extremely susceptible to risk. Additionally, unstable tax laws and other regulations must also be considered. This being said, the company must be very proactive in understanding and abiding to the very different environments in which it obtains its contracts. The next point discusses some of SNC-Lavalins uncontrollable business. Considering the company often relies on third party subcontracting. Third party dependency creates ambiguity for SNC with the possibility of their inability to meet deadlines and contract obligations. The limited control in which the company has over the decisions and operations of its third party partners can also be a risk factor that impacts SNCs reputation, business, financial condition and results of operations. In sum, SNC faces many risks that could adversely affect its operations, financial stability, and corporate image both on a national and international level. These risks, although some uncontrollable, provide enough evidence for our audit team to understand the possibility of Financial Reporting issues, material misstatements, fraudulent activities, corruption, and
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embellishment. Numerous external factors such as their political, economical, and global environment contribute to these risks. Inevitably, SNC finds itself to be in a costly position for the main purpose of avoiding these risks that inherently affect its business ventures such as its ability to acquire future contracts. This being said, global industry conditions, a widely uncontrollable factor, proves to be SNC-Lavalins major obstacle.
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3. Analytical Procedures
Exhibit 2 - Comparison of current and previous year ratios:
Ratios
2012
1. Current Ratio
0.96
42.44
53.21
65.31
78.37% 3.70
77.42% 4.63
Conclusion
Liquidity: The decrease in average days for collection shows improvement for firms liquidity. However, the decrease in current ratio and the increase days to sell inventory display issues in the firm and actions to improve liquidity are necessary.
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Solvency: The leverage is high and increased from prior years. We must also pay close attention to the reduction in times interest earned. Profitability: Although revenues increased from the previous year, profitability seems to have had a significant decline. We should look carefully at revenues & expenses to ensure the legitimacy of these claims. Exhibit 3 - Comparison of current year and industry average ratios:
Ratios 2012
AVG
SNC
1. Current Ratio
1.05
SNC is slightly below its competitors' average, demonstrating the firms inability to pay their 0.96 current obligations at an appropriate level. Significantly above average in inventory turnover. This most likely indicates that there is 42.44 obsolete inventory on hand. A lower than average collection period proves that this firm is able to collect their receivables in 53.21 an effective and timely manner. Well above average in this category. SNC holds 78.37% significantly more debt than their competitors. Being above average in this field indicates that interest expense payments do not strike this 3.70 company as a current issue. As SNC's profit margin is quite low by comparison, it seems that they are having issues 3.83% converting profit into revenue. 3.22% Return on assets is significantly below average. 14.89% Return on equity is also below average.
2. Days to sell inventory 3. Average collection period 4. Debt-to Total Assets Ratio
15.48
62.02
65.73%
3.1
Conclusion
Liquidity: Although SNC has a shorter collection period, their lower current ratio and significantly higher rate of inventory turnover are enough to conclude that SNCs liquidity is an issue. Their short-term debt paying ability is significantly weaker than that of their competitors.
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Solvency: It has become quite apparent that SNC is taking on more debt than their competitors, which is explained by the comparison of debt-to-total assets ratio. That being said, their ability to cover significantly more than their interest expense is well above average, which proves to creditors that they are not as much of a financial risk.
Profitability: All aspects of profitability seem to be well below the rate of their competitors. SNCs poor investments and high expenses have left them in a risky situation, where they rely heavily on high levels of revenue.
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4. Materiality Assessment
The main users of the financials are the shareholders. As such, it is necessary to determine an amount to which a misstatement will affect their decision. Shareholders primary goal is to maximize returns on their investments. These investors will trade based on the discrepancy of their expectations, analysts forecast or available information and the actual results. As such, it is important to them that the financial statements do not contain material misstatements. This will cause materiality level to decrease. It is important to note that SNCs shareholders have lost confidence due to the scandals in recent years. Accordingly, the statements will be examined using professional skepticism and lower materiality levels to detect any embellishment by management in order to achieve certain objectives (management compensation), forecasts (analysts consensus on earnings) or covenants (debt, dividend covenants). For instance, if the company manipulates earnings to avoid a loss, although the misstatement is small, it may still be considered material because of the outcome. In sum, because of the complexity of the organization and recent controversies, this will lead to a reduction of materiality level.
%
15.05% 16.47% 10.37% 12.22% 8.21% 14.65%
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377,606
$ 482,234
(21.70) %
When taking into account all of these factors, we can clearly determine that in order to fulfill shareholders need, a low level of materiality must be established. We have decided to use an overall materiality level of $25,000,000 CAN. The reason behind this amount is that public construction contracts are often very large. With their sales exceeding $8 billion every year, this amount seems like the minimum amount that would affect a users decision. Additionally, we have also set our performance materiality level to 50%, $12,500,000 CAN, which seems to be adequate in detecting smaller errors and preventing them to accumulate into a material one. Lastly, all the accounts that are verified, Pomegranate will test them with respect to all management assertions (i.e. existence, ownership, completeness, valuation, cut-off, and presentation).
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Inherent Risk
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Assuming no internal controls exist, inherent risk is important in determining the overall audit risk. In fact, it is the actual risk of finding material misstatements in the companys Financial Statements. Professional judgment is required in order to assign a number in form of a percentage as the inherent risk. This percentage is based on a variety of factors, which the following table will clearly depict.
Factor
Discussion
M e L d o i w u m
H i g h
Accounting policies are extremely complex; they are active in over 100 countries, having subsidiaries in over 40 countries. Assets must be properly valued in the various currencies which represent them. Unearned revenue from contracts that have not yet been completed can be incorrectly valued or misrepresented due to many external and internal factors that can hinder the completion of the job. Being one of the leading engineering and construction companies in the world (SNC-Lavalin, 2013), we can assume that the company has many competent accounting staff members that actively participate in the proper valuation of their many financial items. The company has employees on an international level that can be of different competence levels. Although we cannot verify their education or level of competency, we can assume that they are of mixed expertise. SNC owns a wide variety of assets ranging from electronics to equipment. This may lead to the risk of asset misappropriation. They also conduct business in Third World countries. Unlike electronics stores however, SNC does not distribute high valued products. They instead use them for their daily operations. They are involved in many countries around the world, in which they hold many locations. The construction industry is also home to numerous complex transactions and contracts. They have many partnerships with third
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parties. In consequence, SNC must develop a complicated organizational structure in order to properly manage its various locations and many employees to ultimately satisfy their investors. The company has undergone many organizational changes, including the appointment of new Chief Executive Officer and President Robert G. Card. The company has taken many other measures to strengthen its management. This means new Board Members, and many other role variations between executives. Nonetheless, these changes are due to past corruption and fraudulent activities. Its operations involve a variety countries; it must therefore survive in different economies, many in which arent on par with that of Canada and the United States. Examples of these Third World countries are Uganda, Cambodia, Nigeria, Bangladesh, India, and Kazakhstan.
6) Economic conditions
SNC has been subject to past and current investigations 7) Actual or regarding fraudulent activities. Former CEO and suspected fraud Executive VP are currently being held by Swiss affecting the authorities regarding the matter. These allegations are entity related to a Quebec and Bangladesh Project. 8) Management incentives to manipulate earnings 9) Doubts about management integrity A Performance Share Unit and Deferred Share Unit Plan were put into place as compensation for management and employees. These directly relate to the companys financial performance, and can be subject to manipulation for personal compensation. Management integrity is questioned due to the various involvements with corruption and Fraud. SNCs management has previously been linked to these allegations, and their integrity must therefore be investigated Previous Audits have found that there were certain payments that were unrelated to projects towards which they were documented. Deloittes Audit Committee has previously recognized this problem. Investigations have commenced since the first quarter of 2012. Profits generated from related-party transactions are accounted for using the equity or full-consolidation methods. Revenues are consequently eliminated from the X
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periods in which they occurred, with the exception of profits which have been realized by the Infrastructure Concession Investments (ICI), their Capital division Considering SNC operates in many industries, including Mining, Engineering, Construction, and Infrastructures, its revenues, although unrelated, are considered to be routine transactions. However, it received more than $376 million from Other industries. These revenues are in line with the $372 million they received in 2011 from similar transactions SNC-Lavalin is a new client to Pomegranate. For this reason, we must be more implicated in the assessment of Audit Risk
13) Initial engagement (new client) Conclusion: Overall inherent risk level =
High (75%)
Control risk Although Deloittes previous involvement with the audit procedures of SNC-Lavalin proved the company to have implemented effective internal controls, SNC remains a new client to our firm. We must therefore be vigilant in the analysis of their internal control procedures. The companys CEO and CFO are in charge of supervising and evaluating the companys internal controls. Considering the previous CEOs involvement in fraudulent activities, internal controls may be jeopardized. Deloitte has been meeting periodically in order to discuss financial reporting, management information systems, accounting policies, auditing and financial reporting issues. This being said, Pomegranate has assigned a Medium (50%) risk to the probability of the internal control policies and procedures to fail to detect or prevent material misstatements.
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Detection Risk Detection risk is the risk that material misstatements, followed by SNCs internal control procedures, will remain undetected by our firm. In order to infer this probability, we must understand the relationship between Inherent Risk, Control Risk, Detection Risk and Audit Risk. This number will affect the scrutiny needed in applying Audit Tests. Audit Risk (1%) = Inherent risk (75%) Control Risk (50%) Detection Risk (DR) Audit Risk (1%) Inherent risk (75%) Control Risk (50%)
2 Audit Risk (1%) Detection Risk (2 %) = 3 Inherent risk (75%) Control Risk (50%) Detection Risk is therefore valued at 2 3 %. Substantive procedures are required in order to assess the monetary amount of material misstatements in SNC-Lavalins Financial Statements and their control deficiencies. These amounts can be verified using two methods: 1) tests of the details of transactions, balances, and disclosures; 2) analytical procedures applied to produce circumstantial evidence about specific monetary amounts in the accounts (Smieliauskas, & Bewley, 2013). The probability that these tests will fail is 2 3 %.
2 2
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6. Conclusion
SNC is a sophisticated organization involving complex alliances, joint operations and related-party transactions. As such, these relationships in essence will trigger incorrect or imprecise amounts with respect to financial reporting, though not necessarily material. This being said, substantive tests as well as tests of controls are required in order to satisfy the 99% level of Audit Assurance we require to provide SNC-Lavalin investors. These tests will be effectuated to address specific Audit Issues that our team has discovered. For example, the companys presence in over 100 countries complicates the audit by implicating various foreign currencies. This consolidation, complex all on its own, does not prove the valuation methods used to be correct. On that note, misstatements may be present due to valuation uncertainties and manipulation through foreign currencies. Secondly, our team has found it unusual that according to their 2011 and 2012 Financial Statements, revenues increased by 12.21% while net income had decreased by 18.5%. Where was this increase in revenues reinvested? Was it reflective of their performance? In comparison to their competitors averages, SNC-Lavalin seems to be doing poorly in many aspects. These questions and observations must be further analyzed. This seemingly poor performance makes them less attractive to potential investors.
Taking into account that SNC-Lavalin is a new client to Pomegranate; the audit team has decided to accept no more than 1% for the Audit Risk. In order to achieve this quality for the investors, we have chosen a low overall materiality level in order to satisfy most of users needs. We will examine all the quantitative as well as qualitative factors when detecting misstatements. To conclude, many tests must be implemented and carefully planned to adequately investigate the financial statements.
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References
Barnes, R. (n.d.). SNC-Lavalin Shakes Up Management RanksDesignBuild Source Canada. DesignBuild Source Canada. Retrieved October 1, 2013, from http://designbuildsource.ca/2013/01/snc-lavalin-shakes-up-management-ranks/
History | SNC-Lavalin. (n.d.). SNC-Lavalin | Home. Retrieved October 1, 2013, from http://www.snclavalin.com/about_history.php?lang=en
Ligaya, A. (2013, September 18). Canada now dominates World Bank corruption list, thanks to SNC-Lavalin. Financial Post | Canadian Business News, Investing and Commentary. Retrieved October 2, 2013, from http://business.financialpost.com/2013/09/18/canadanow-dominates-world-bank-corruption-list-thanks-to-snc-lavalin/
Seglins, & Nicol, J. (n.d.). SNC-Lavalin offices in Algeria raided amid bribery probe . CBC.ca Canadian News. Retrieved October 1, 2013, from http://www.cbc.ca/news/canada/snclavalin-offices-in-algeria-raided-amid-bribery-probe-1.1348485
Smieliauskas, W., & Bewley, K. (2013). Auditing: an international approach (6th ed.). Toronto: McGraw-Hill Ryerson.
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