(14, May, 2010)Santos Limited In Australia (Case Study) Inherent Risk FactorsInherent risk is the probability that there are misstatements in an audited section in an organization that arise out of existing circumstances and before the implementation of internal controls. In assessing the inherent risk the audit is expected to apply his professional discretion. Inherent risk – Nature of the industry (ASA315 Appendix 1)Santos Limited operates in gas production which is an industry that is susceptible to market fluctuations and volatility as a result of growth in demand and different product specifications as demanded by the consumers, the different quality in crude oil and the influence of the new investors in the market.
The global economic crisis had an effect on the oil prices where there were frequent price changes within the year. This is possible to have an effect on the stock prices as stated in the financial statements. The stock prices affect both the income statement in calculating the cost of sales and the balance sheet while recording the stock balances. Hence the focus will be on the cost of sales and in the calculation of the realizable value.
There was a big decrease in the profit that is attributable to the shareholders (BusinessDay, 2010). This has mainly been attributed to the change in prices affected by the global crisis, and partly by demand from other countries and more specifically the Asian population and mostly China. The price and demand changes may also be affected by new oil explorations globally. Therefore is a need to analyze all the figures that affect financial statements. Therefore the sampling of the audit will need to be a wide one so as to cover all areas with the intention to conduct audit that will be very thorough.
However the inherent risk in this report will concentrate mostly on other reports that are not in the financial statements and reports of Santo Limited. The reports are available in the newsrooms and in the public media. Santos was also planning to sell it stake to in Evans Shoal to Magellan. The inherent risk in this are and what is questionable is the possibility that the transaction between Santos and Evans Shoal (Santos limited, 2010).
The auditor would need to audit on the integrity of the officers who are dealing with the transaction. There is a possibility that if these officers are not of high integrity they may collude and overprice the sale. In planning to conduct the audit in this particular transaction the auditor needs to take into consideration the factors that may lead to an inherent risk. The integrity of the new managing director and possibly the board maybe a possible contributing factor that will lead to the misstatement or rather the overstatement of the sale.
ISA 400 gives the integrity of the management as one of the examples of factors may affect inherent risk in an organization. Being a new managing director it would not be easy to predict his business managing skill. In April 2009 it was reported that the company was lying off 140 staff members and another 90 of them contractors were to be terminated in responding to the effects of the global crisis. There is an inherent risk whereby the company may fraudulently or by error fail to make provisions for the final dues to these employees.
Paying 140 employees may result to a material figure both in the income statement and the balance sheet. This provision is in accordance with ISA 37 Provisions, Contingent Liabilities and Contingent Assets of International Financial Reporting Standards (IFRS). This risk may be affected by two factors that are given as examples in the ISA 400. One of them is the possible lack of knowledge by the accounting officer that any material figures that may affect the company’s financial position should be provided for.
The next factor is the pressure to show positive performance after the profits decline reported in the financial year 2009. The management may be tempted to hide some of the figures so as to show an increase in profit. The integrity of the management will also contribute. Integrity is crucial for the accounting staff. This is because there are called to be representatives of the shareholders, which they should deliver through without favor. These figures should include any pension dues and any leave pays that the employees may not have taken. There is a 40 percent tax increase from 6 percent on profit that is to be paid to the government by the oil companies.
According to the news reports the Managing Director, David Knox said that this tax increase proposal could push out the final investment and paralyze investment. There is an inherent risk here first if the tax will be adjusted and provided for in the Financial. The results of this increased tax will a major impact in the figures and any tax additional amount should be provided for in the accounts.
The accountants should be well informed as such a failure to make the provision would completely distort the profit that is attributable to the shareholder (BusinessDaily, 2010). A failure make the actually payment, and on good time may attract heavy penalties on Santos Limited. According to ISA 400 conditions within the industry may be a factor that affects inherent risk. This causes turmoil in the industry making it a bigger risk. The knowledge of the accountant will also be a contributing factor to consider if this will actually be a risk.
The effect on the tax increment creates another inherent risk. According to the managing director the investors had stopped their investing making it more difficult to raise funds and thus delaying the project. This statement may raise a few questions that may affect the inherent risk. The first risk is in the delay of the implementation of Gladstone liquefied natural gas, GLNG (Cosserat, 1999). There are funds that have already been raised for this project. The money is in the bank accounts.
Cash is very tempting while it is in liquid cash as there is always the possibility of it being misappropriated. This may be affected by the integrity of the management. The third risk that may lead to an inherent risk and that can increase the inherent risk and that is questionable is if the delay is really as a result of the tax increase or it could be an indirect way of the managements plan to have more time to collect more funds (Khanna, 2010).
There are reports that the project maybe under budgeted. As such the management may be playing delay tactics in order to collect more funds to finance the project. According to John Macbee, an analyst with the a Royal Bank of Scotland, there is the possibility that the budget would exceed the $7.7billion and suggestions to make it a joint venture with Shell BP. This plus the fact that there will be delay in finalizing the project GLNG may show that there is a risk of funds being not enough.
Santo limited has sold its assets in the year 2008 and again in 2009 and it has also been reported that it is selling its stake in Evans Shoal. This shows a risk of misstatement of the budget. This maybe affected by several factors that are in ISA 400 among them the management experience, unusual pressure and the nature of the business. According to Pritchard, (2008) the oil and gas industry is affected by frequent oil prices. It is therefore not very possible to give accurate budget figures.
The recorded reduced profits of the financial year 2009 profit may have led to investors inserting pressure on the management. This may lead to wrong figures being presented to the investors in order to please them and help them retain their jobs. In so doing the management may have under-budgeted the GLNG project. There was a change in management in the year 2009 and whereby it was reported that there was some displeasure from the former Chief Executive Officer who in order to please him he had to given the position of the CEO.
Investigations should be directed towards finding out if there was a possibility of figures being distorted by the employees who were loyal to him. In this case the investigations should be started with senior accounting staff to establish their loyalty. Deeper investigations should be directed towards those areas where the staffs were loyal and their figures verified. To give an example, if the Invoicing Manager was loyal to the form CEO, the invoices should be audited more thoroughly with a narrowed down sampling. The financial statements may report some discrepancies that need to be affect the inherent risk.
The assets recording needs to be investigated. The change in depreciation charge in the income statement is not proportionate to the change in assets. Considering that there is a recorded additional cost of asset of $523m and if we put into consideration the disposal of assets as evidenced by the sales proceeds of $260m then the change in the depreciation change recorded should be more. There is a possible misstatement of the assets that could be aimed at impressing the investors who need to be encouraged to raise new finance to fund the new GNLG.
This could be affected by the integrity of the management, the unusual pressure put on the management to perform and the unusual constraints that are experienced in the oil industry. The writing off of $202m in 2009 of capital expenditure was written off as unsuccessful exploration. This should be investigated because it could have had an effect on the 2008 financial reports which may lead to adjustments of the 2008 published accounts. It is an unusual transaction whose amount is material and the audit plan should investigate how that figure may have been calculated in the year 2009.
The global prices were very low in the year 2009 as compared to 2008. There is a possibility that the amount would have been used as a ‘hidden provision’ in 2008 so as the profits published would be attractive to the investors. A risk that is caused by lack of integrity by the management. An Adelaide based company had analysed the Santos 2009 financial statements and had indicated that much of the profits reported in 2008 was as a result of Santos selling its stake in Queensland liquefied natural gas.
Such reports will also show a weakness and an inherent risk by misrepresenting figures and especially if this had not been a disclosure in the reporting. Other factors apart from lack of integrity in the management that would contribute is the complexity of the transactions. This is more so if the management have not had such a transaction in their records in the previous financial statements. Again the management maybe under pressure to perform hence misrepresentation of figures.
Another news report by businessday had indicated that the reports that the investors were anxious over the failure or reluctance of the management to provide them with Capital Expenditure requirements of Gladstone liquefied natural gas (GLNG). This should be a source of a possible inherent risk whereby the figures are misstated so as to retain their confidence. This could result to misstatements in all areas of the financial statements, that is, the assets, and equity shares, understatement of the liability, expenses being understated and cash misappropriated.
In this case the situation will have been affected by all the ISA 400 examples, the integrity of directors and management, the experience of the management and Directors, unusual pressures on management to perform exceptionally well and conditions within the industry. There are reports that indicate that Shell BP should get into a joint venture with Santos. John McBee continues to suggest that a tie up that is expected between Santos and Petronas and Petronas and Shell Petro-China should not be ignored but should be taken positively by the market.
As Macbee continues and suggested that Petronas and Santos “should stop to invest in hardly valued-enhancing single train development. These statements contain an inherent risk in that there is a possibility that the investment with GLNG has not been properly analysed. This can lead to increase the already anxious investors to stop investing. This can be supported by the delay in the final plan of the implementation of the project. This inherent risk is affected by lack pf proper skills in this new venture and again the unusual pressure.
With the investors making their demands to have their returns from investing in the venture. Another factor affecting the inherent risk is the conditions within the industry. The oil industry business has its complexities. There is always a risk involved caused by unpredictability of the prices and other factors.