Section - 2 Case-2.4 [PDF]

Zitiervorschau

ASHER FARMS INC Understanding of Client’s Business Environment INTRODUCTION Asher Farms, Inc. is a fully-integrated poultry processing company engaged in the production, processing, marketing and distribution of fresh and frozen chicken products. Asher Farms sells ice pack, chill pack and frozen chicken, in whole, cut-up and boneless form to retailers, distributors, and casual dining operators principally in the south-eastern and south-western United States. During its fiscal year ended October 31, 2014 the company processed 343.6 million chickens, or approximately 2.0 billion dressed pounds. Based on industry statistics, Asher Farms is one of the largest processors of dressed chickens in the United States based on estimated average weekly processing. Asher Farms’ common stock is traded on the NASDAQ national market with an aggregate market value of $677 million on October 31, 2014. Asher Farms’ chicken operations presently encompass 7 hatcheries, 6 feed mills and 8 processing plants employing 1,059 salaried and 8,646 hourly employees. The company has contracts with operators of approximately 530 broiler farms that provide the company with sufficient housing capacity for its current operations. Asher Farms also has contracts with 173 breeder farm operators and 44 pullet farm operators. INFORMATION ABOUT THE AUDIT Asher Farms is required to have an integrated audit of its consolidated financial statements and its internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Your firm, Smith and Jones, PA., recently accepted Asher Farms as an audit client and as a staff auditor you have been asked to obtain some preliminary information about the poultry industry to provide a basis for understanding the client’s business environment. Background information about the poultry industry from Smith and Jones’ industry database is provided for your review. REQUIRED 1. A useful approach for understanding a client’s business environment and associated business risks is to perform a PESTLE analysis. PESTLE is an acronym for Political, Economic, Social, Technological, Legal and Environmental factors that are used to asses the client’s business environment. A PESTLE analysis focuses on factors that may affect an entity’s business model, but are beyond the control or influence of the client. While beyond management’s direct influence, such factors may significantly impact an entity’s business risk. Read the background information about the poultry industry and conduct additional research on the internet to obtain the latest news and information on the industry. Brainstorm political, economic, social, technological, legal and environmental factors that could affect Asher Farms’ business risk. Unless your instructor indicates otherwise, identify at least one business risk factor for each component of the PESTLE acronym. 2. For each of the business risk factors identified in question 1 above, indicate how each risk factor might impact the risk of material misstatements in specific financial statement accounts or disclosures. 3. Professional auditing standards provide guidance on the auditor’s consideration of an entity’s business environment and associated business risks. (a) What is the auditor’s objective for understanding an entity’s business environment? (b) Why does an

auditor not have responsibility to identify or assess all business risks? (c) Provide some examples of business risks associated with an entity that an auditor should consider when performing an audit. (d) Provide some additional examples of business risks that might not lead to a risk of material misstatement in the financial statements.

ANSWER 1 & 2 The increasing demand for animal products resulting from demographic factors, technical and scientific developments, diminishing resources, and increasing consumer demands for more food safety, lower environmental impact, and better animal welfare conditions will determine the development of the poultry industry during the next decade. Here are the components of PESTLE contributed to the business risks of Asher Farms, Inc.: P – Political Regulation for Broiler Production  After decades of rapid expansion, growth in both broiler production and productivity began to slow in the mid-1990s. Slowing growth creates challenges for industry decision makers, as they consider how to encourage further investments in capacity and new technology, and attempt to manage existing and aging production networks. The broiler industry has a unique organization. Firms called integrators own processing plants, hatcheries, and feed mills, and contract with independent “growout” operations to raise their broilers to market weight. The contractual relationship between farmers and integrators, however, is coming under growing scrutiny from Congress and regulatory agencies, and the industry relies heavily on a particular kind of production contract that has attracted considerable attention. Corporate Bureaucracies Hindered Improvements in Innovation  Capital management will be subjected to stringent corporate evaluations and assessments, such that the time to complete a project and its successful outcome could be jeopardized by inefficient corporate bureaucracies. Therefore, implementing clear, concise procedures for managing this process efficiently is critical to long-term success of the new technology program and the poultry company’s long-term survival. E – Economic Sensitivity of Production Prices  Broiler production is gradually shifting to larger operations, a trend common to most agricultural commodities. As a result, operators of larger enterprises may be more sensitive to the income risks arising from energy price fluctuations and contract settlements. Contract features may need to be redesigned to adjust for differing risk exposures faced by growers.  Overall production growth slowed sharply after 2000. While per capita consumption continued to grow at 1.9 percent per year, the contribution of population growth fell in comparison to earlier years and export growth fell sharply. But changes in exchange rates can affect the competitiveness of U.S. exports, and growth in foreign incomes can be an important force. In the near future, a declining dollar, combined with income growth in Asia, may boost export growth again.  It is expected that prices for raw materials will remain low due to new market developments and introductions, improved technology offerings, especially herbicide resistant crops, and genetically engineered crops with improved economic traits. All of these changes translate into lower costs per unit of available nutrient, and as such, will provide most companies with inexpensive raw materials costs with which to produce their products.

Rigorous Competition  The poultry industry from its inception has been largely a cost driven industry. As such, feed prices and the ingredients that comprise a finished poultry feed have typically represented65-70% of the cost of live production and therefore a focal point for most managers trying to save money. Recently, and with the evolution toward further processing and value added production, producers can now effectively lower their total feed costs as a percentage of total costs of production by investing capital into further processing equipment and the production of value added products. However, it is clear that opportunities exist for companies that can continue to move toward further processed, value added products that meet consumer demand for convenience, wholesomeness, safety, and palatability at a reasonable price. Investing in capital to achieve these higher margin product offerings is the wave of the future and will be the new arena of competition in the industry.  Competition is fierce and is today still largely driven by the cost of manufacturing and the quality of the output or product sold to the customers. As demand for poultry products slows around the world, the next wave of consolidation in the industry will occur. Larger companies will continue to get larger and poultry plants will be designed larger still to capture all possible scale economies. Getting larger for these companies means that transportation issues on effectively manage supply will become ever more critical to address and resolve for long term company sustainability.  It is believed that feed prices, like grain and soybean prices will remain soft, given noun foreseen dramatic reductions in yield due to droughts or other factors that might impact a healthy harvest, globally. Moreover, the continued oversupply of these grains, compounded by US price supports, and new improved technologies, including herbicide resistant grain sand other improved varieties that achieve higher yields, will continue to keep prices at or below the 9 year average for the foreseeable future. Price Advantages Are Limited  The industry’s rapid productivity growth has been driven, in large part, by improved poultry genetics, but also by steady improvements in structures, equipment, and production practices. These improvements, taken together, have led to greater feed efficiency, lower mortality, and more intensive use of capital and labor services— essentially, raising the output of broiler meat that can be achieved for given inputs of feed, fuel, capital, and labor inputs. Slowing investment in new housing could reduce the industry’s productivity growth and, in turn, limit any price advantages over other meats. S – Social Convenience and Quality Contributed to Growth of Consumption  The demographics of the consumer as already mentioned has changed and will continue to change over the foreseeable future but with a continuing trend toward embracing convenience and quality. The poultry products consumer of tomorrow will be a cross between the retiring baby boomer of today and the sophisticated Gen-Xer that will continue to balance career, family and household management with food protein solutions that are cost effective, convenient and wholesome. That includes the selection of protein food sources that are part and parcel of a total nutrition program that delivers quality, safety and convenience at a reasonable price. This translates to pressures on the poultry industry to significantly reduce or eliminate any risk of food borne pathogens, reducing or eliminating the use

of antibiotics and/or other controlled additive usage in the feed, and providing products that are tasty, tender, and convenient to prepare at a reasonable price. Healthier Diet Consciousness  Fanatical pressures on the meat industry in general and the poultry industry, specifically will continue to create doubt in the consumer’s minds about the wholesomeness of meat products in general and poultry products specifically; both from a health standpoint and from an animal welfare perspective. However, a more powerful, opposite influence, based on ongoing, empirical, scientific evidence, is the endorsement of credible nutritionists and dietitians that the consumption of poultry products is paramount to achieving a well balanced, high protein, lean, healthful diet to prevent obesity, heart disease and diabetes.These forces are also in play in the global arena and will likely spur additional growth in third world countries as these nations improve their overall nutritional programs and the quality of food choices available to their citizens. T – Technology Genetic Engineering  Feed stuffs should no longer be considered as commodities. Qualitative and nutritional criteria should be used for their purchase and segregation in feed mills. Technologies allowing the immediate analysis of feedstuffs, such as NIRS, will be required. Genetic engineering will become an important tool to improve feedstuff nutritional quality and, perhaps bird performance.  Growth modelling and data-analysis using computer systems will allow more robust decision-making, which will be the key for the sustainability and success of the poultry industry. Moreover, new technologies on the live production side must be implemented to both ensure source of supply and improve the overall efficacy of production so that profitability from the further processed end products will be maximized. Technological approaches that accelerate improvement in the supply situation include genetics programs that create ever more efficient, fast growing, high yielding birds.  In addition, hedging futures commodities to lock in future costs will continue to be critical in managing the overall cost structure, future risk and uncertainty of the supply side of. This area of raw material management will require a more accurate and precise global perspective of the dynamically volatile international markets to ascertain the impact of these global changes on domestic grain prices. To that end, decision-enhancing models that assess the impact of these changes will become more valuable to companies who wish to manage this process with precision and accuracy. o Financial Statement Accounts/Disclosures that could be affected: Revenues, inventory If the company does not keep pace with technological advances it could find itself at a competitive disadvantage negatively impacting its ability to sell chicken at a profit. L – Legal Immigration Labor 

Immigration reform continues to attract significant attention. New immigration legislation at the federal or state level could make it more difficult or costly for the company to hire United States citizens and/or legal immigrant workers. Also,

increased enforcement efforts with respect to existing immigration laws by governmental authorities could disrupt a portion of the workforce in the industry and thus adversely impact production of chicken products. o Financial Statement Accounts/Disclosures that could be affected: Cost of sales, revenue The company may have to pay higher labor costs or may not be able to produce and sell as much poultry. Unique Manners in Managing Contracts  Other industries use production contracts, but the broiler industry is distinguished by the dominance of such contracts and the methods by which growers are paid. Almost all broiler growers’ contracts base the compensation on how each grower’s performance compares with that of others. Beyond that feature, however, contracts are far from uniform. Variations in contract design likely follow from differences in grower location, size, and type of broiler housing, but the wide variation in terms and payments makes it difficult for growers to evaluate contracts. Long durations tend to be offered to newer and larger operations. Among recent entrants, those with longterm contracts averaged half again as much production as those with shorter contracts. Contracts and Competing Integrators  Because production is so localized, most producers have few integrators to choose from. Those findings may overstate the number of integrators farmers can choose among if some integrators are not actively seeking new growers. Integrators must recruit growers away from other activities, such as producing other commodities on the farm or working off the farm. Those outside options for growers set limits on the degree to which integrators can impose low fees on growers. There is little empirical evidence, however, of the effects of integrator concentration on grower returns. Once a contract has expired, growers may have to retrofit their houses with new capital equipment in order to gain a contract extension. These expenditures can be substantial.

Food Safety  Chicken producers are subject to international, federal, and state laws and regulations concerning food safety standards and processing, packaging, storage, distribution, advertising and labeling of chicken products. Non-compliance could adversely affect the cost of producing or ability to sell chicken products. o Financial Statement Accounts/Disclosures that could be affected: Cost of sales, revenues, inventory The company may have to pay higher production costs or may not be able to produce and/ or sell as much poultry. 

Regulatory changes concerning the discharge of chicken manure by government agencies could adversely affect the cost of producing or ability to sell chicken products.

o Financial Statement Accounts/Disclosures that could be affected: Cost of sales, revenues, inventory The company may have to pay higher production costs or may not be able to produce and/ or sell as much poultry. 

Agricultural policies of the United States and foreign governments all affect the supply of feed and could adversely impact the cost of feed. o Financial Statement Accounts/Disclosures that could be affected: Cost of sales, revenues

The company may have to pay higher production costs or may not be able to produce and sell as much poultry. 

Imposition of tariffs, quotas, trade barriers and other trade protection measures imposed by foreign countries like Russia, China, Mexico, etc. could impact demand for chicken products causing domestic chicken prices to decline. o Financial Statement Accounts/Disclosures that could be affected: Revenues, inventory

The company may not be able to sell as much poultry E – Environment Litter Disposal Contamination  Larger operations may realize scale economies in production, but they also concentrate poultry litter in localized areas. Litter disposal remains a major issue confronting the industry. Global Warming  Global warming could affect weather patterns that could adversely impact the production of feed and chicken products. The changing weather patterns could have a negative impact on the cost of chicken products. o Financial Statement Accounts/Disclosures that could be affected: Cost of sales, revenues The company may have to pay higher production costs or may not be able to produce and sell as much poultry.

ANSWER 3 a. The auditor must obtain an understanding of the entity and its environment to assess the risk of material misstatement and to design the nature, timing, and extent of further audit procedures to perform. b. Not all business risks give rise to risks of material misstatement. The auditor needs to consider those business risks that could result in a material misstatement at either the financial statement level or assertion level to classes of transactions, account balances, and disclosures. c. Appendix C of AU Section 314 provides examples of business risks that could give rise to material misstatements. Some examples provided are:        

Operations in regions that are economically unstable, for example, countries with significant currency devaluation or highly inflationary economies. High degree of complex regulation. Marginally achieving explicitly stated strategic objectives. Constraints on the availability of capital and credit. Changes in the industry in which the entity operates. Changes in the supply chain. Developing or offering new products or services, or moving into new lines of business Expanding into new locations.

d. Most business risks will eventually have financial consequences. However not all business risks will give rise to material misstatements. A few examples of business risks that might not lead to a risk of material misstatement in the financial statements may include:   

Employee stealing petty cash funds. Employee use of company office supplies for personal benefit not company benefit. Employee running a personal side business from company facilities.