These are agreed procedures engagements;
Accountants are frequently requested by individuals or companies to investigate a business or a company of which the client is contemplating purchase. What the accountant is being asked to do is to help his client make up his mind on whether to buy or not and if to buy at what price and for what consideration. The accountant's approach will depend on his instructions. An investigation of this nature might be carried along the following lines:
i. Obtain written instructions. This is to determine the purpose of the investigation and any particular criteria the client may wish to apply. So, we must know the cash availability, the consideration to be offered, the minimum return on the investment, the scope and cost of the investigation.
ii. Establish contacts. The accountant must open up a relationship with his client, the subject of the investigation, its professional advices particularly accountants and auditors.
iii. Examine and redraft the accounts for a period of years. This is usually taken to be 3 years, one year being considered too short because there are no comparatives, two years being considered too short because there is no trend, three years being considered optimum because you have a comparative and trend. More than three years is considered to be purely of historical value. Under this stage, we eliminate all the non-recurring items and all items which will not apply after the change of ownership and we include notional amounts for items that will become applicable after the change of ownership. These may involve redrafting of the accounts using different accounting policies.
iv. Establishing the reliability of the accounts: If they have been audited by a well recognized firm, then little verification is required apart from considering any qualifications in the auditors reports and the appropriateness of the accounting policies used. If the accounts have not been audited, then you require some more information in the following areas:
- Sales: You have to investigate for inclusion of fictitious sales or sales from other businesses;
- Purchases: Look out for exclusions;
- Cut off: This is important as potential sellers are well known for switching sales into final periods to boost turnover and profits;
- Work in progress and stock: It is important to check the quantity and value sometimes an independent stock take should be arranged at the take over date;
- Gross profit ratios: This should be consistent year to year and with the industry average;
f) Asset valuations: Adequacy of depreciation and the value of debtors need to be looked at critically. Look out to see whether necessary repairs and renewals of assets have been ignored;
g) Undisclosed liabilities: Items may include pension obligations compensation for redundancies and taxation liabilities.
v. Commercial considerations: The various factors to be considered include:
- Requiring a knowledge of the spread of customers and products;
- Knowing the development plans for the district;
- Length of leases of premises and the possibilities of renewal;
- The continuity of trading arrangements;
- The personal connections of the vendors will the customers continue to patronise the business after change in ownership;
- Personnel considerations;
- The need for an agreement that the vendor will fill in from original.
vi. Future prospects: The important factors here are:
- The future of the industry;
- The future of the enterprise within the industry;
- The capital working needs and the fixed assets investment needs, you may find cash flow forecasts essential;
- Miscellaneous issues: Your client will be interested in being given facts upon which he can form an opinion. He would also like to know the reason for the sale of the business and he may be interested in working methods that are ordinarily used for valuing businesses.