Suncorp_-_Inherent_Risk

1. Use of Estimates Inherent risk – Key account balances are determined on estimates Suncorp uses estimates and judgements to determine account balances or the following key accounts (Financial Report Note 1): • General insurance – outstanding claim liabilities and assets arising from reinsurance contracts • Impairment of goodwill As the account balance is based on estimate and judgement it is inherently risky. The issue is that the balance is basically based on a guess so there is a significant chance it is incorrect because there is no way to determine if it is right or wrong. Why is it an inherent risk' The use of estimates to determine account balances is inherently risky as it is a complex calculation based on judgement. The chance of material misstatement is high due to the way the balance is calculated. Misstatement can occur in the following accounts in the following ways: • Outstanding claims liabilities – potential to understate liability which can distort the Financial Position of Suncorp. In addition it can lead to Going Concern issues if they have not provided sufficiently for potential liability which may result in issues with paying it later. • Assets from reinsurance contracts – potential to overstate certain assets which do not represent a fair presentation of Suncorp’s financial position. This again will have issues with Going Concern. • Impairment of Goodwill – if not valued correctly it can infect goodwill position. Evidence Inquires with the client to determine method for calculating estimates and ensure it is in line with prior years. Calculations will need to be re – performed to ensure estimates are calculated accurately. Where estimates are calculated using a third party professionals such as Actuaries, reports can be obtained to see that balances are in line with the third party. When third party professionals are used, the third party also needs to be evaluated to determine if we can rely on their reports. Run analytical procedure to ensure current balances are in line with prior year balances and that it makes sense and if there are significant fluctuations, it needs to be made sure they are in line with the business. 2. Sale of Wedding Cake Tower The flagship Suncorp building in Brisbane has been sold to a private investor for about $65 million. Carter (2011, p.1) Inherent risk – Sale of Wedding Cake Tower The sale of the Wedding Cake Tower is a “non – routine” transaction. Suncorp is in the business of banking and insurance and not in the sale and purchase of property. The inherent risk is that as it is not in Suncorp’s normal course of business it may be incorrectly recorded as key Suncorp personnel may lack the required experience or knowledge to record the transaction. Why is it an inherent risk' Error in recording the transaction can lead to material misstatements in the Property Plant and Equipment (PPE), depreciation and proceeds from sale of Property Plant & Equipment. Misstatement can occur in the following accounts in the following ways: • Property Plant and Equipment – Incorrect amount written off in the books, which can lead to the Property Plant and Equipment balance being overstated. • Depreciation – Not a full yeah of depreciation, so it needs to be ensured the correct amount has been taken up down to days (this is closely linked to PPE cost write off) • Gain on sale of asset – if Property, Plant and Equipment write off is incorrect then the gain will be overstated which will incorrectly show a better financial performance picture. If incorrectly written off it will also inflate revenue and also inflate cash flows. Evidence Other revenue/Cash flow – obtain the sale contract to determine the sale price and identify any convents and contingencies associated with the sale. If and when there is a large transaction, like the sale of the Wedding Cake Tower, normally the buyer will put in contingencies (example – they have to get a minimum amount of rent guaranteed or otherwise they won’t pay the full price, or they may decide they only wish to pay a certain amount up front and the rest of the sale price will be paid on Suncorp meeting certain conditions). So therefore need to look at the contract of sale to ensure no contingencies. Cash – obtain confirmation to determine that the cash balance reflects the proceeds from the sale and/or see bank statements which should show the physical payment. Property, Plant and Equipment – review costing to ensure appropriate amount has been removed from the books. Need to also do more significant work of the disposal of the Property, Plant & Equipment such as substantive testing to determine the correct figure and control testing to ensure that the correct procedure followed to authorise the disposal of the building. Depreciation – ensure correct amount has been calculated, as it is not a full year of depreciation. Ensure it has been correctly calculated and the correct amount has been removed. Carter, A 2011, ‘Suncorp to reap $65 million from sale of Wedding Cake Tower’, The Australian, 26 May, p.1 http://www.theaustralian.com.au/business-old/property/suncorp-to-reap-65m-from-sale-of-wedding-cake-tower/story-e6frg9gx-1226062918364 3. Related party transactions Suncorp has been caught in a massive trawl of structured finance arrangements by the Inland Revenue, which is investigating whether big multinationals have been paying their fair share of tax. The giant Australian insurer, which owns Vero, Asteron, Comprehensive Travel Insurance and two thirds of AA Insurance, maintains there was nothing wrong with two related party transactions with a total revenue of over $600 million that appear to have caught the taxman’s eye. Homer (2011, p.1) Inherent risk – Related Party Transactions (ASA315 Appendix 1) The transactions are not at “arm’s length” therefore may not be recorder in the same way and in the same amounts – as if it was a transaction with a third party. Why is it an inherent risk' Transactions between parent and subsidiary companies are examples of related party transactions. Because these transactions don’t occur between two independent parties dealing at ‘arm’s length’, a greater likelihood exists that they might be misstated, which should and will cause an increase in inherent risk. There is a risk that they were not valued at the same amount as they would have been if the transactions had been with an independent third party. Most auditors assess risk as high for related party transactions, because of both the accounting disclosure requirements and the lack of independence between the parties involved in the transactions. Arens et al (2011, p.267) Evidence Enquire with Suncorp management to determine related party transactions Obtain a listing of all subsidiaries and see if any have been transacted with during the period in question (example – check if there are any Accounts Payable, Accounts Receivable, Property, Plant and Equipment transfers etc.) Homer, R 2011, ‘IRD puts heat on Suncorp’, Sunday Star Times, 01 May, p.1 http://www.stuff.co.nz/business/4947051/IRD-puts-heat-on-Suncorp 4. Potential merger with BOQ The Bank of Queensland has raised the possibility of a merger with Suncorp’s banking business to create a fifth force in Australian banking. From Suncorp’s perspective a merger is desirable because an independent Bank of Queensland would always constitute a competitive threat and an alternative home for Queensland banking customers. The merger would eliminate that threat and enhance any premium to the net asset valuation of the business in a float. Lekakis (2009, p.1) Inherent risk – merger Suncorp would want to get the best possible deal, and in that case would want to show the best results possible, hence there is a chance for fraudulent reporting. Why is it an inherent risk' Suncorp would want to show a strong financial position and a strong financial performance to look a healthy corporation and attractive to merge with. Therefore the potential for fraudulent reporting is as follows: Revenue – may increase through factious customers to show a better position. There also might be a cut off issue with revenue being recognised in the correct period to show better results for the current year. Cash – they would want to show a stable working capital position so therefore there is a chance for fraudulent reporting. Evidence Control testing over new customers to ensure a proper procedure is being followed and to ensure fictitious customers cannot be created. Cut off – do detailed testing over cut off by selecting invoices/new customers made in the year in question and ensuring that revenue is recorded in correct period. Cash – obtain bank information to ensure correct amount. Lekakis, R 2009, Suncorp and Bank of Queensland merger on the cards ‘’, Courier Mail, 21 May, p.1 http://www.couriermail.com.au/business/suncorp-merger-rumours-persist/story-e6freqmx-1225713783728 5. State of Economy/Nature of the Industry (ASA315 Appendix 1) One of Australia’s biggest reporting agencies says the global financial downturn is still hurting people, with one in six Australians struggling to pay off their debt. Veda advantage says a fair 20%of those in debt are actually looking for additional credit to help pay off their existing debts. In these tough economic times Australians have really felt it hit their pockets. Australian Lending Centre (2011, p.1) Inherent risk – State of Economy/Nature of Industry (ASA315 Appendix 1) The survey conducted by Veda comes at a time when a growing number of economists are starting to think that the worst of the global downturn is coming to an end. However there continues to be a segment of society that is still doing it tough – this could also be associated with the now larger unemployment rate. Australian Lending Centre (2011, p.1) A significant proportion of Suncorp’s business involves banking and lending of money. As interest rates rise and unemployment rises people will struggle to pay back their outstanding loans. The inherent risk here is that the accounts receivable is overstated as it does not take into account people’s inabilities to repay their outstanding loans. Why is it an inherent risk' Banking loans, advances and other receivables (Financial report, p.53) – is overstated due to monies not being able to be recovered are included in the balance. Bad debts – understated as money not recoverable are not taken into account. Evidence Obtain the debtors ageing reports to see any long outstanding amounts. For ones identified, review correspondences with customer to determine if they will pay this amount back or decide if it needs to be written off. Obtain list of which customers have missed payments and review what is being done about it. Are the customers on a payment plan or does the accounts receivable need to be written off. Australian Lending Centre, 2011, “Aussie Families Struggling with Debt ‘’, Australian Lending Centre, 23 May, p.1 http://www.australianlendingcentre.com.au/news/2011/05/aussie-families-struggle-with-debt/ 6. Management experience Patrick Snowball, chief executive of Suncorp – Metway has unveiled a shake-up of the company’s senior management team, announcing the appointment of two senior executives and saying goodbye to personal insurance boss Bernadette Inglis. Mr Snowball is also expected to announce appointments for the positions of chief financial officer, chief risk officer and head of human resources, all of which are currently vacant. Sharat (2009, p.1) Inherent risk – management experience Mr Snowball is expected to announce appointments for the positions of chief financial officer, chief risk officer and head of human resources, all of which are currently vacant. Why is it an Inherent risk' Inexperienced management may result in accounting errors such as a failure to make necessary provisions or to make relatively complex calculation correctly etc. This is particularly likely to happen with a change in management. Evidence Perform and obtain detailed controlled testing to ensure procedures are being followed. Because when there is a change in personnel/management they don’t always know the controls in place, so things can be easily missed. So the first thing will be to do a detailed control testing over specific processes (example – payroll, to review monthly pay runs and ensure they have gone through the proper steps and authorisation) Another example is accounts payable - to review invoices to ensure they have gone through the correct approvals for payment etc. Substantive testing – depending on what process (example – with payroll a predictive analytical procedure will need to be done to see and check payroll is in line with prior year and if the movement of up or down is in line with expectations. Sharat, 2009, ‘Suncorp’s new chief enacts senior management changes’, Money AU, 22 October, p.1 http://www.money-au.com.au/finance-news/banking/suncorp%E2%80%99s-new-chief-enacts-senior-management-changes-5468/ Part 2 – Overall assessment of inherent risk Inherent risk and control risk assessments are related to the frequency and magnitude of misstatements as suggested by the audit risk model. The use of the audit risk model allows for a planned level for audit risk, assessment of the overall inherent risk and control risk and come up with the appropriate level of detection risk. Misstatements occur as a result of inherent risk factors. For example, misstatements may occur due to inherent risks such as incompetent personnel/management who do not conduct control procedures properly that can lead to an increased occurrence in misstatements as mentioned above in question 1. If management are motivated to meet forecasts or to show better financial reports for any purpose and the control environment is weak, misstatements are likely to occur. The assessment of the inherent risk component of the audit risk model occurs at the beginning of the audit by evaluating specific risk factors as we have done in question 1. In assessing the control risk, we need to get a deeper understanding of the internal control of the business. In Suncorp’s case the overall assessment of inherent risk is high and the level of testing given needs to be determined. The steps involved in determining the evidence mix are: Evidence mix Risk assessment procedures – as per ASA315 obtain an understanding of the entity and it’s environment including its internal control, to assess the risk of material misstatement in the financial statements. Substantive test of transactions – this will be testing for monetary errors to determine whether the six transaction – related audit objectives have been satisfied for each class of transactions. Substantive tests of transactions are used to verify transactions recorded in the journals and posted in the general ledger. Analytical procedures – involve comparisons or already recorded amounts against amounts or expectations developed by the auditor. (ASA 520) When expectations are developed using analytical procedures and if it’s concluded that the client’s ending balances in specific accounts appear to be correct, than some tests of details of balances may be eliminated or sample sized reduced. Analytical procedures emphasise the overall reasonableness of transactions and the general ledger balances. Tests of details of balances – are tests on the ending general ledger balances for both balance sheet and income statement accounts. The primary emphasis however in most tests of details of balances is on the balance sheet. Tests of ending balances are essential because the evidence is obtained from a source independent of the client, therefore it is considered highly reliable. Tests of details of balances must satisfy all balance related audit objectives for each significant balance sheet account. Test controls – it tests the effectiveness of controls in support of a reduced assessed control risk. The emphasis on the type of tests in any audit depends on the circumstances of the client. The nature, timing and extent of substantive testing are determined by the assessed level of inherent and control risk. Increased reliance on controls will allow for the reduction of substantive testing, however some substantive procedures will always be performed irrespective of the planned control risk. REFERENCE LIST Arens, AA, Best, PJ, Shailer, GEP, Fiedler, BA, Elder, R, Beasley, M, 2011, Auditing – Assurance Services & Ethics in Australia, Pearson, Australia, Sydney Australian Lending Centre, 2011, Aussie Families Struggling with Debt , Australian Lending Centre, viewed 12th of October 2011 http://www.australianlendingcentre.com.au/news/2011/05/aussie-families-struggle-with-debt/ Carter, A 2011, Suncorp to reap $65 million from sale of Wedding Cake Tower, The Australian, viewed 15th of October 2011 http://www.theaustralian.com.au/business-old/property/suncorp-to-reap-65m-from-sale-of-wedding-cake-tower/story-e6frg9gx-1226062918364 CPA Australia 2011, Auditing, Assurance and Ethics Handbook, Pearson, Australia, Sydney Ferguson, A 2010, Suncorp is hatching a corporate restructure that will create opportunities for deals with other regional banks SMH, viewed 19th of October 2011 http://www.smh.com.au/business/bank-on-a-suncorp-separation-20101108-17knh.html Homer, R 2011, IRD puts heat on Suncorp, Sunday Star Times, viewed 15th of October 2011 http://www.stuff.co.nz/business/4947051/IRD-puts-heat-on-Suncorp Lekakis, R 2009, Suncorp and Bank of Queensland merger on the cards, Courier Mail, viewed 16th of October 2011 http://www.couriermail.com.au/business/suncorp-merger-rumours-persist/story-e6freqmx-1225713783728 Sharat, 2009, Suncorp’s new chief enacts senior management changes, Money AU, viewed 22 October 2011 http://www.money-au.com.au/finance-news/banking/suncorp%E2%80%99s-new-chief-enacts-senior-management-changes-5468/