Due Diligence
1 Introduction
Due diligence is typically required when one company is proposing to takeover another. Essentially due diligence is fact finding and information gathering: exactly what is being bought?
The target company’s published financial statements give some information, but not enough, and besides the financial statements could be over a year old. Financial statements are historic, showing what has happened, but what is being bought are the future prospects of the business and the new owner will end up with both the assets and liabilities of the acquired business.
A due diligence assignment could be either:
A review engagement to provide limited assurance (negative opinion) to the effect that nothing worrying has been found.
An agreed-upon procedures engagement to report factual findings.
2 Procedures
Often, due diligence assignments are urgent. For example, the take-over is happening to rescue a failing company. However, the auditor must take care to ensure that there is a comprehensive engagement letter and that staff of the proper skills and experience can be assigned to the job. Typically, the engagement letter will cover:
Extent of the work.
Type of report.
Timescale.
A clause saying that any takeover is the decision of the client, not the auditor or accountant.
A clause stating that misstatements made by the target company might not be discovered, that all irregularities might not be found and a description of the nature of the work. For example, of a review nature (ie making inquiries and performing analytical procedures) but may include other procedures (eg inspection, external confirmation).
A clause stating that the auditor is dependent on the cooperation of the target company’s management.
The fee. (May create self-interest threat if the potential purchaser is an audit client.)
3 Information to be reviewed
A due diligence review will be concerned with the target's assets and liabilities - not all of which will be reflected in the financial statements (eg intangible assets that cannot be recognised) - and future prospects. The range of information that may be reviewed is generally very broad:
Budgets.
Information about senior employees and their contracts of employment.
Liabilities that have arisen since the issue of the most recent financial statements.
Pending litigation.
Prospects for the business.
New products in the pipeline.
Industry outlook.
Non-current asset information not revealed by the financial statements (eg age of assets and replacement plans).
Lease contracts.
Significant contracts, progress, renewal dates, performance, transferability, termination (eg on change of business ownership)
Correspondence with major customers.
Proof of payment of corporation tax, employees PAYE, VAT etc.
Accident book.
Board minutes.
A review might also need to consider issues that might be critical to a successful takeover, for example:
Whether the target company's culture 'clashes' with the buyer's.
The extent to which the target's systems are compatible with the buyers.
Specific operational matters (eg manufacturing processes or inventory control).