CORPORATE FINANCE

08 Auditing
Case study
1 Read the text and discuss these questions with a partner.
a What problem does Petersham Electricals have?
b Have you ever encountered a problem like this?

Petersham Electricals has just bought one of its competitors, a relatively small company in the same industry.
The acquisition went ahead fairly smoothly, with the shareholder directors of the acquired company providing
all the usual warranties. No one really believed that these warranties would be required.
However, the finance team has just discovered serious irregularities in the accounting practices of the
acquired company. The directors of this company (who have remained with the business following the
acquisition) have no financial knowledge themselves, and for several years they have been outsourcing the
company’s financial operations to a part-time, third-party business consultant. This consultant has had several
sets of annual accounts audited by a reputable accounting firm, but despite this, he had made fundamental
errors in accounting for the company’s revenues and this materially affects its value. It has become obvious to
the finance team at Petersham Electricals that the company is worth considerably less than they paid for it.

2 Geoff Stansfield, CFO at Petersham Electricals, has called a meeting to talk about the situation and decide what
to do. In groups of three, discuss what you think the options are, decide what you think the best option is and be
ready to present your case at the meeting. Make some notes below to help you.

3 This problem was actually resolved two years ago. Read what Geoff Stansfield says about what happened next.
How does this compare with what you decided?

It would have been very easy to take action against the shareholders who bore ultimate responsibility under
the warranties. However, the effect of this could have been demoralizing and distracting at a time when we
needed them to be upbeat and positive in the post-acquisition period. Instead, it was agreed that we would
undertake legal action on their behalf to recover damages from the consultant for the loss in value of the
business, and that the funds recovered would be passed through to us.
This strategy was successful. Sufficient funds were eventually recovered to cover the loss in value sustained.
No momentum was lost in building the acquired company, and, in fact, revenues doubled in the two years
following the acquisition.

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In Company 3.0 ESP Corporate Finance © Macmillan Publishers Limited 2017 WORKSHEET