Auditing – The Case Book Due Diligence

DUE DILIGENCE

QUESTIONS

Q.1 Tortoise Publishing (Pvt.) Limited (TPL) is a publisher of children books which is part of curriculum for major schools in
Pakistan. TPL is planning to expand its business and diversify into Educational Technology Business. For this purpose,
TPL is considering to acquire a business namely Swan Technology Enterprise (STE). TPL has requested your firm to carry
out a due diligence for acquisition of STE.

After initial discussion for the due diligence exercise, your team has brought the following matters to your attention:

(i) In 2018, STE was formed as a partnership concern by two software graduates, Saleem and Sabir. Initially, they
had designed and developed the application for schools which included Student Management System and
Learning Management System. This application manages all the data related to curriculum learning material,
billing to students, student educational records and tracking of assignments given to students. Due to shortage
of funds, they were not able to market its application properly and were able to sell the application to few
schools only.

In early 2019, Saleem and Sabir had secured significant funds from an investor to finance the growth and
expansion. Thereafter, a marketing team was recruited at attractive packages to market the application and an
administrative team was also set up to look after the accounts and other administrative tasks. However, the
marketing team has not been able to penetrate into the market as expected.

(ii) TPL believes that since it has good connection with many schools due to its publishing business, they can not
only market the application in a more aggressive way but can also exploit synergies by using TPL’s marketing,
finance and administrative teams. TPL also has a plan to market this application to schools situated in under
developed countries.

Required:
Identify and explain any six matters which you may consider in your due diligence review. Also recommend any three
additional information that you may need in respect of each matter identified by you. (15)
(ICAP, CFAP 06 Level – Winter 2021, Q.# 3)

Q.2 You are employed as an audit manager in Bashir and Company, Chartered Accountants. One of your clients, Davidsons
Pharma Limited (DPL), is considering to acquire 60% shareholding in Sehat Healthcare (Pvt.) Ltd. (SHPL) and has
requested your firm to carry out a due diligence.

During the fieldwork of due diligence exercise, your team has brought the following matters to your attention:
(i) A major customer which accounts for 10% of SHPL’s annual sales has refused to place further sale orders. On
inquiry, it was revealed that competitor has offered significant discount of 12% to increase its market share.
(ii) DPL has central distribution model where single distributor has non-exclusive rights countrywide with commission
rate of 5%. All sales made to the distributor on 30 days’ credit. On the Other hand, SHPL has a regional distribution
model where multiple distributors are involved country wide with commission rates ranging from 2% to 4%. Under
this model, all sales are made on cash.

Required
Discuss how the above matters are to be investigated for due diligence review and also recommend the additional
procedures to be performed in this respect. (12)
(ICAP, CFAP 06 Level – Winter 2020, Q.# 7a)

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 Auditing – The Case Book Due Diligence

Q.3 Your firm has been approached by Eagle Courier Limited (ECL) to provide due diligence review on a potential acquisition.
ECL is a leading courier service company having a network of offices throughout the country. ECL has a vast fleet of
delivery vans and motorcycles.

ECL intends to use its courier industry experience and expand into food delivery business by using its current fleet of
motorcycles. However, it would require bringing on board a vast number of restaurants and build its own online food
ordering website, of which they do not have any expertise and experience.

For this purpose, ECL has identified an online food ordering business Foodi.com (FC) for acquisition. FC is a partnership
concern and was set up by three college friends in 2014. FC received the best ‘start-up business’ award in 2015. Founders
of FC had borrowed funds from two individual investors, which are to be repaid in 10 years.

IT, restaurant relation, customer support and administrative departments are led by the partners. Being an online service
business, the only major assets of FC are a fleet of motorcycles obtained on an operating lease of 5 years and computers.

Apart from 500 riders, FC employs 30 staff, out of which 10 are related to IT department, 10 belong to customer support,
5 belong to restaurant liaison and the remaining 5 are responsible for the accounts, HR and administration of the
business.

Extracts from audited profit or loss statement for four years are as follows:
2017 2016 2015 2014
-------------------- Rs in million --------------------
Revenue 55,000 50,000 20,000 10,000
Operating expenses (34,650) (30,000) (16,000) (15,000)
Lease rentals (5,750) (4,600) (2,875) (1,150)
Operating profit/(loss) 14,600 15,400 1,125 (6,150)
Finance cost (3,075) (3,155) (1,615) (1,615)
Profit/(loss) for the year 11,525 12,245 (490) (7,765)

Required:
Identify and explain the matters you would focus on in your due diligence review. Also identify any additional information
/ document you would require during the review. (15)

(ICAP, CAF 03 Level – Summer 2018, Q.# 2)

SUGGESTED SOLUTIONS

A.1

Examiners’ Comments:
Examinees failed to identify the following matters and the related additional information:
• STE, being a partnership business, is not subject to regulation and oversight of corporate regulatory authorities and the
auditor would need to inquire about the financial reporting framework used.
• Software’s capability to protect the student’s data from any type of breaches.
• Determining scalability and the reliability of the software.

Marking Plan:
 01 mark for identification and explanation of the matter 6.0 marks
 0.5 mark for any additional information needed in respect of the identified matter 9.0 marks

Passing Percentage:
28%

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 Auditing – The Case Book Due Diligence

A.2

Examiners’ Comments:
• Examinees did not discuss that how the matters are to be investigated for due diligence review.
• Examinees produced verification procedures which were related to an audit engagement instead for due diligence.
• Examinees did not mention the following procedures:
• Obtain any correspondence to identify any renegotiation occurred on the terms of their agreements.
• Analyze the impact of aggressive competitive marketing strategy to offset the impact of discount offered by competitor.
• Inquire the management about the possibility of offering discount by analyzing the profitability analysis.
• Assess the goodwill of brand name may have any impact in offsetting the impact of discount.
• Review the subsequent sales trend to analyze the magnitude of loss of sales and measures taken by management
accordingly.
• Examinees failed to mention the procedures related to the effects of difference among the distribution model followed by
both the companies.

Marking Plan:
 01 mark for discussion on the matters to be investigated 2.0 marks
 01 mark for each additional procedure 10.0 marks

Passing Percentage:
21%

A.3

Examiners’ Comments:
This was a scenario based question in which the candidates were required to discuss the matters which they would focus
while performing a due diligence review under the given scenario. They were also supposed to identify any additional
information which they may require during the review. The performance in this question was extremely poor and only 7%
could secure passing marks. About 62% of the candidates secured three or less marks in this 15 mark question.

Majority of the students seemed to have very little idea of the important aspects which are considered in a due diligence
review. Accordingly, most of the answers revolved around analyzing the data given in the question irrespective of the
significance of each type of information. Moreover, very little or no emphasis was placed on other important areas such as (i)
role of partners and in the absence of any experience of similar business, how would the acquirer manage the business (ii) is
there any key staff and would they continue (iii) terms of employment of the existing delivery staff who would have to be
relieved, (iv) are the financial statements audited and (v) other off balance sheet items.

Even the analysis of data was weak in many cases as the following matters were discussed by few students only:
• Why the finance cost remained constant in 2014 and 2015
• Which assets have been leased and would the lease continue
• Why there is no provision for taxation
• What are the details of operating expenses
While discussing the other important information/documents required, items like bank details, legal advisor’s details,
contracts with restaurants and suppliers, etc. were mostly ignored.

Marking Plan:
 01 mark for explanation of each matter to be focused in due diligence review 10.0 marks
 0.5 mark for identification of each additional document/information 5.0 marks

Passing Percentage:
7%