 Due Diligence

 PFI
 Social and Environmental Audit
 Forensic Accounting

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 Audit-related services
 Audit-related services are those services that
professional accountants offer but which are not
statutory audits, although they are conceptually
related and use similar skills.
 Audit Audit Related Services
Audits Review Agreed-Upon procedures
Reasonable, But not 100 Limited Assurance No Assurance
% Assurance
Positive assurance on Negative Assurance on Factual Findings of
assertions Assertions procedures
 The circumstances in which audit-
related services are required
Reviews/assurance engagements Agreed-upon procedures
 Financial statements review (e.g. for  Forensic audit.
small companies).
 Interim financial statements reviews.  Verifying insurance claims.
 ‘Due diligence’ assignments.  'Due diligence‘ assignments.
 Benchmarking/KPI reviews.
 Due diligence
 Due diligence is a "fact finding exercise" and is usually
conducted to reduce the risk of poor investment decisions.
 An advisor is engaged by the potential acquirer of a
company to undertake a comprehensive survey of the
target, in order to make sure the potential acquirer enters
into the transaction with "open eyes".
 Depending upon the client's requirements, a professional
opinion may be expressed. Alternatively, the investigations
may result in the presentation of factual findings.
 Therefore it may either be conducted as an assurance
assignment or an agreed upon procedures assignment.
 Types of due diligence
 This type of due diligence can be categorised into three areas:
1. Financial due diligence: analysing and validating the target's
revenue; maintainable earnings; future cash flows; and
financial position including identification and valuation of
contingent liabilities and key assets.
2. Operational due diligence: investigation of the operational
risks; cost base; asset base; capex requirements; quality of IT
and other systems; key customers and suppliers; and
performance gaps of the target company.
3. Commercial and market due diligence: a comprehensive
review of the target's business plan in the context of the
industry and market conditions; including compliance with
relevant legal, taxation, and regulatory frameworks.
 Purposes of due diligence
 Decrease management time spent assessing the acquisition
decision
 Identification of operational issues and risk assessment of the
target company
 Liabilities evaluated and identified
 Identify assets not capitalised
 Gathering information
 Enhance the credibility of the investment decision
 Planning the acquisition
 Claims made by the vendor can be substantiated
 Evaluation of possible post-acquisition synergies and economies
of scale and potential further costs
 Procedures
1. Enquiries of relevant parties
2. Analytical procedures.

 Typical procedures may include:

 A verifying the existence of the assets the target company claims to have
 A verifying the ownership of these assets
 A reviewing company forecasts for reasonableness
 A analytical procedures on the target’s management accounts since the last
year-end (as these results have not been audited)
 A checking contracts with key employees, customers, suppliers etc. as any of
these may be due to finish, or there may be terms in the agreements relevant to
a takeover (e.g. an employee may have the right to resign without notice if the
ownership of the company changes)
 A checking employee contracts as some may be entitled to a payout on a change
of ownership
 A likewise, checking lease agreements for similar clauses
 A assessing whether the change in ownership would create tax liabilities, or
cause loans to be repaid.
 What is ‘prospective financial
information’?
 Prospective financial information (PFI) means financial
information based about events that may occur in the future and
possible actions by an entity. It may be in the form of a forecast
or a projection, or a combination of both.
 A forecast is:
 PFI prepared on the basis of assumptions as to future events that
management expects to take place and the actions management
expects to take (best estimate assumptions).
 A projection is:
 PFI prepared on the basis of hypothetical assumptions about
future events and management actions that are not necessarily
expected to take place.
 Principles of useful PFI
 PFI can be issued:
 as an internal management tool, e.g. to support a possible
capital investment; or
 for distribution to third parties, for example:
 in a prospectus
 in an annual report
 to inform lenders or to support an application for finance.
 The unifying qualities of good PFI are that reports must:
 address the specific needs of the user
 be prepared on a timely basis to enable decisions to be taken.
 Acceptance of PFI engagements –
matters to consider
 The intended use of the information, such as internal
management or external users.
 Whether the information will be for general or limited
distribution.
 The nature of the assumptions (e.g. best estimate or
hypothetical).
 The elements to be included in the information.
 The period covered by the information.
 Level of assurance
 Due to the uncertainty surrounding forecasts and
projections, and due to the limited nature of the
procedures performed during the accountant's review, only
limited assurance can be offered for PFI engagements.
 The opinion will be expressed negatively, i.e. 'Nothing has
come to our attention to suggest the assumptions used in
the forecast don't provide a reasonable basis for the
forecast'.
 The terms of engagement
 The nature of procedures performed, i.e.
predominantly enquiry and analytical procedures.
 The type of assurance offered, i.e. limited.
 The form of opinion given, i.e. negative.
 Management's responsibilities, which are, mainly, to
prepare the
 PFI report and to establish appropriate assumptions.
 Restrictions on the use and distribution of the
assurance report.
 The basis of setting the fees.
 Procedures
 Typical procedures may include:
 enquiry of management as to the assumptions in the estimates
 a review of the reasonableness of these assumptions
 a comparison of forecasts with the most recent actual figures
 a comparison of forecasts with industry expectations
 a comparison of the accounting policies used in the forecasts with
those used currently
 ratio analysis to ensure figures are internally consistent
 enquiry of management as to any planned policy changes in the future
(e.g. a decision to give extended credit to customers to try to boost sales
should be reflected in higher debtor days, more bad debts etc.)
 enquiry of management as to any changes in laws likely to affect the
company during the forecast period
 analysis of the figures to ensure easy-to-forget items have not been
omitted – a profit forecast should include depreciation, bad debts,
settlement discounts, loan interest, tax etc.
 Further procedures
 It may be possible to do more specific work on some items
in the forecasts:
 A payroll costs may already be agreed with staff
 A the cost of new assets may have been agreed, and contracts
signed / quotes obtained
 A sales early in the forecast period may already have been
fixed (e.g. orders received, deposits taken, contracts signed)
 A depreciation on assets that already exist, interest on current
loans is already fixed.
 Contents of PFI report
 Title and addressee.
 Identification of the subject matter i.e. the forecast information.
 Reference to any applicable laws or standards (e.g. ISAE 3400).
 A statement that it is management's responsibility to prepare the PFI.
 Reporting accountant's responsibilities and basis of opinion.
 A reference to the purpose and distribution of the report.
 A clear written expression of limited assurance as to whether anything has come to
light to suggest that:
 the assumptions are not a reasonable for the purposes of the PFI.
 the report is not prepared on the basis of those assumptions.
 the report is not in accordance with a relevant financial reporting framework.
 Appropriate caveats about the achievability of the results given the nature of
assumptions and inherent limitations in the forecasting process.
 Date of the report.
 Reporting accountant’s signature and address.
 The need for social and environmental
reporting and assurance
 Many companies now develop and maintain social, ethical and
environmental policies that can vary from highly generalised
statements of ethical intention to more detailed corporate guidelines.
 In addition to reporting on the use of shareholder funds, businesses are
now expected to account for their impact on the social and natural
environment.
 Integrated reporting is now common for companies where instead of
focusing on purely financial performance within the annual report,
other performance measures are included such as targets in relation to
corporate and social responsibility matters.
 Key performance indicators (KPIs)
 KPIs or business performance measures are financial and
non-financial statistical measures that are chosen and
monitored to determine the strategic performance of an
organisation, including those factors of performance that
are critical for the continued success of the organisation.
 Monitoring of KPIs enables performance to be evaluated in
comparison to benchmark performance criteria or progress
to be compared to the results of competitors.
 The need for assurance reports on
social and environmental reports
 Many companies now publish social and environmental
reports. Auditors may be engaged to report on the fairness
and validity of KPI benchmarking exercises. This
independent review will add credibility to the social and
environmental data published and give assurance to
external users that the progress claimed by a company’s
management is in fact real progress.
 This type of review is an example of an attestation
engagement and is often referred to as an environmental
audit.
 Planning an engagement
 Understanding and agreeing the scope of the engagement, i.e. is assurance to be
provided on the outcome and measurement of the KPIs only, or on the fairness and
validity of the entire KPI benchmarking exercise (e.g. including the appropriateness
(and completeness) of the measures chosen).
 Obtaining an understanding of the entity.
 Considering the appropriateness of the KPIs chosen in the light of this understanding,
ensuring the KPIs chosen represent the priorities of the company.
 Evaluating the KPIs to ensure that each measure is quantifiable and to ensure that
evidence will be readily available to support the stated KPI.
 Reviewing and agreeing the KPIs over which assurance is to be provided, f lagging any KPIs
that are not specific enough to measure accurately, and over which assurance can therefore
not be provided.
 Identifying the evidence that should be available in relation to each KPI in order to provide
an assurance opinion.
 Considering the potential for manipulation of each KPI, to achieve the desired result, i.e.
identifying those KPIs which present the highest engagement risk.
 Procedures
 Enquiry of management and experts.
 Recalculation of figures to verify arithmetical accuracy
 Inspection of supporting documentation.
 External confirmation from third party certification
providers.
 Reporting
 Where a review is carried out by an independent third
party into the environmental matters of an organisation, an
independent verification statement may be issued.
 Some companies conduct an internal audit on
environmental matters and have the internal audit verified
by external assessors.
 Some companies may contract for a third party
independent review of their environmental matters.
 What is ‘forensic accounting’?
 The field of forensic accounting is a specialist branch of the profession carried out by
forensic accountants and encompassing forensic auditing and investigation.
 Forensic accounting
 Uses accounting, auditing, and investigative skills to conduct an examination into a
company’s financial affairs.
 It is often associated with investigations into alleged fraud.
 It involves the whole process of conducting an investigation, including acting as an expert
witness.
 Forensic investigations
 This refers to the practical steps that the forensic accountant takes in order to gather
evidence relevant to the alleged fraudulent activity.
 Such investigations involve a planning phase, a phase of gathering evidence, a review
phase and a report to the client.
 Forensic audit
 This refers to the specific procedures adopted in order to produce evidence and report on
findings.
 From an accountancy perspective, this usually requires the adoption of traditional
financial auditing skills and techniques.
What do forensic accountants do?
Application Examples
Fraud Theft of company funds,
investigations tax evasion, insider
dealing.
Insurance claims Business interruptions,
property losses, motor
vehicle incidents,
personal liability claims,
cases of medical malpractice,
wrongful dismissal.
Professional Loss suffered as a result
negligence of placing reliance on
professional adviser.
Shareholder, Determination of funds
partnership and to be included in
matrimonial settlements, as benefits
disputes or distributions.
Type of work performed
Funds tracing, asset identification and
recovery, forensic intelligence gathering,
due diligence reviews, interviews,
detailed review of documentary
evidence.
Detailed review of the policy from either
an insured or insurer’s perspective to
investigate coverage issues,
identification of appropriate method of
calculating the
loss, quantification of losses.
Advising on merits of a case in regards
to liability, quantifying losses.
Detailed analysis of numerous years
accounting records to quantify the
issues in dispute, tracing, locating and
evaluation of assets.
 Planning a forensic audit
 Planning the investigation will involve consideration
of similar matters to those involved in planning an
audit.
 Procedures
 Enquiries/interviews of key staff, including the ultimate interview with
the suspect/s.
 Detailed inspections and analysis of documentary evidence.
 Substantive procedures including reconciliations and cash counts.
 Tests of control to identify deficiencies and, hence, opportunity to
commit fraud.
 Analytical procedures to compare trends over time or between business
segments.
 Computer assisted audit techniques, for example to identify all
payments to a specific bank account number.
 The report
 As an agreed upon procedure the most important
factor of a forensic report is that the practitioner
adequately addresses the requirements of the client, as
established in the engagement letter.
 A basic report will include:
 a summary of the procedures performed
 a summary of the results of procedures
 any limitations in the scope of the engagement
 a conclusion regarding the amount of any losses suffered.