Question

You are a manager in the business consultancy department of Eagle & Co, a firm of Chartered Certified Accountants. You have been assigned to perform a due diligence review for Panther Co, an existing audit client of your firm. Panther Co is involved in the manufacture of automobile parts. The company is currently being audited by a separate audit team to reduce any potential self-review threat to an acceptable level, and you have no prior involvement in its audit.

The scope of the engagement involves conducting a due diligence review on the fundamentals of Flamingo Co, a prospective acquisition target identified by Panther Co for the potential to realize synergies from the proposed business combination and expand its existing manufacturing plants. You have been requested to analyze Flamingo Co's operating profit forecasts and perform a valuation of its net assets as part of your assignment. The outcome of your review will aid Panther Co in ascertaining a suitable purchase consideration for the acquisition of Flamingo Co.

The following matters have been identified by your team during the engagement fieldwork and referred to you for your further consideration:

1. During the review of Flamingo Co's correspondence with its customers, a letter from Pelican Co, a large distribution centre, was discovered. In the letter, Pelican Co expressed its intention of not renewing their trade contract with Flamingo Co upon the expiration of the current one. The reason cited for this was that they are switching to a different supplier, a new market entrant, whose prices are far more competitive than Flamingo Co. Historically, Flamingo Co has supplied bespoke parts to Pelican Co, and preliminary analytical procedures revealed that Pelican Co accounts for an average of 4% of Flamingo Co's annual revenues.

2. Flamingo Co possesses a parcel of land which was gifted to it by the municipal council a decade ago. The land is a protected nature reserve and is located adjacent to Flamingo Co's main manufacturing site. Encumbrances were stipulated in the land's title deed which limit the manner in which the land may be used and to whom the land may be sold to. The land has a carrying value of nil in the company's non-current asset register.

Required:

In respect of each matter highlighted above:

(i) Explain why it requires further consideration as part of your due diligence review,

(ii) Recommend the examination procedures to be carried out.

Answer 1

Lost customer of value 4%of revenue

The due diligence is being conducted for the purpose of potential acquisition of the entity

The entity recently lost a major customer thus it is further required to inquire the actual customer is lost.
We have to check whether the management have disclosed the same in the notes to accounts as it is a significant activity.if not it should included in the due diligence report as it significantly influences the acquisition price.

Further we have to check all the revenue receipts and cross check the same by sending letters to customers to confirm the same.

Land of protected nature

This needs to considered during the acquisition process as this will have significant impact of acquisition price.

Read the contract between the municipal and the entity.
Check whether the land can be sold to acquirer.if it can be sold due to the limited usage verify it will be of any use to the acquirer.
Check whether this is disclosed by the management if not report the same in your due diligence report